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Falling Yen is Biggest Risk to South Korea ETF

Posted
4/29/2013 12:43:00 PM
By: Benzinga
Referenced Stocks:EEM;EWY;VWO

The bad news, part of the bad news anyway, is that the iShares MSCI South Korea Capped Index Fund (NYSE: EWY ) is down 12.5 percent year-to-date. That makes EWY, one of the largest country-specific emerging markets ETFs by assets with over $3.26 billion, a laggard among funds tracking emerging Asian economies.

The good news, in the eyes of some investors, is that South Korean equities are now viewed as inexpensive. Famed emerging markets investor Mark Mobius of Franklin Templeton has said as much and he is correct.

EWY has a P/E ratio of 14.68 and a price-to-book ratio of 1.62, according to iShares data . Based on those numbers, EWY's valuation is less expensive than what is found on the iShares MSCI Emerging Markets Index Fund (NYSE: EEM ) or the comparable Thailand and Philippines ETFs, just to name a few.

Unfortunately for South Korea bulls, stocks there can easily get cheaper. Of the more frequently cited risks to EWY and South Korean stocks there is the obvious, that being the looming specter of an attack from volatile North Korea. Then there is the notion that selling of South Korean stocks by Vanguard is an issue.

Vanguard, the third-largest U.S. ETF issuer, is transitioning the Vanguard FTSE Emerging Markets ETF (NYSE: VWO ) to the FTSE Emerging Markets Index. The FTSE Group does not classify South Korea as an emerging market, which means Vanguard has been selling South Korean stocks. However, the market has known for more than six months Vanguard would be doing so and, to Vanguard's credit, the firm's sale of South Korean shares has orderly and gradual .

In other words, the biggest risk to EWY and South Korean stocks is the plunging Japanese yen. South Korea has been among the most vocal critics of Japan's weak yen policy and it is easy to understand why.

Should South Korea's won gain 10 percent against the yen, the result could be a 1.9 percent year-over-year reduction in South Korean exports in the current quarter, according to Yonhap News Agency .

"As the U.S. dollar-yen exchange rate is nearing the ratio of (one dollar) to 100 yen, we are facing increasing threats the depreciating yen may bring to South Korea's exports," Yonhap reported, citing South Korea's Ministry of Strategy and Finance.

On January 1, JPY/KRW traded around 12.185. Today, the yen trades at 11.2825 against the won . At the start of this month, JPY/KRW was trading above 12.

That comes after the won gained 4.7 percent against the Japanese currency in the first quarter. Mobius also acknowledged the risks the falling yen poses to South Korea.

"South Korea's market also bears some risk from further weakness in the Japanese yen. Yen fluctuations can impact South Korea more than some other economies in the region because South Korea competes directly with Japan in the manufacture and export of value-added, high-technology products and machinery," he noted in a recent blog post.

Regarding EWY, South Korea expects the weaker yen will be more damaging to small and medium-sized firms, implying large conglomerates such as Samsung may prove somewhat sturdy. Samsung is EWY's largest holding at 23.1 percent of the ETF's weight.

That does not mean EWY will be completely insulated from the falling yen, but it could mean there is a fair chance EWY does end up with valuations that are even more attractive than what the ETF currently sports.

For more on ETFs, click here .

(c) 2013 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.

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