Samsung Headlines Korea's Top Heavy ETF

Samsung Electronics represents 24% of the Korean exchange-traded fund (EWY) which has come alive this year after trailing other Asian markets over the past few years and was up 1.92% Wednesday alone. Samsung has become Asia's largest technology company by market cap (larger than Sony (SNE)), and its largest maker of memory chips and flat panel screens and mobile phones. Samsung enjoys a credit rating higher than South Korea's sovereign rating. With 62 affiliates, the Samsung group dominates life in Korea like no other company in history. It represents 15% of the nation's total economic activity, 25% of the capitalization of the KOSPI stock market and the taxes it pays represent almost 10% of total government income!

But the company is not a terrific play on the South Korean economy. Rather it is a global play on its three key markets and the expected payoff from its extraordinary commitment to R&D. The South Koreans are discontented because the five largest companies are growing outside the country more than in it and at a stage of development where it should be more competitive manufacturing onshore. The challenge is the low cost manufacturing platform with huge economies of scale just next door: China. Samsung already has already has 29 plants and 50,000 workers in China.

Since China is already starting to manufacture things, such as machine tools, that the South Koreans were busily exporting in 2003 and 2004, South Korean planners believe it must quickly transform itself into a finance, communications and transportation hub, akin to the role of Singapore or Switzerland. The question then becomes does it have the right companies, the right skills and what is its competitive advantage?

Together, Samsung, POSCO (PKX), KEPCO (Korea Electric Power) and SK Telecom (SKM) account for almost 50% of South Korean stock markets market capitalization. To use a basketball analogy, the South Korean starting five are strong but its bench is a bit thin and its team has lost the home court advantage. The problem is not Samsung but rather that they need about ten more Samsungs.

The top four companies also make up 40% of the South Korea iShare (EWY) ETF which is up 29% so far this year. Samsung alone accounts for 23% of this ETF and buying the iShare gives you more exposure to the top ten South Korean companies. A stronger won and higher interest rates might lead to slower growth, and the likely reemergence of the North Korean problem may very well undermine investor confidence, but the momentum of the market may offset some of these risks.

Earlier this year we increased exposure to South Korea in some of our ETF Portfolios after seeing that it was attractive on a relative valuation basis.

EWY 1-yr chart