KOSPI rebanacing due after crash
By Cho Jin-seo
Foreigners sell, Koreans buy; foreigners may return to buy when, or if, the messy problems regarding government debts in their home countries are solved. But when they do return, they will find that their influence has shrunk in the KOSPI market, analysts say.
Local investors — whether they be pension funds, professional investors or housewives who trade at home — are going to take a larger portion of the stock market as their wealth increases faster than counterparts in Western countries.
“Foreign ownership will probably structurally decline in Korea, but not because foreigners abandon Korea. The economy is getting stronger with each cycle,” said Shaun Cochran, head of research at CLSA Korea. “The difference is that as Korea ages it will put more money into equities which will drive a long-term re-rating in equities.”
John Ford of Fidelity International agrees.
“Foreign investors continued to make up a large share of market turnover across Asia, Korea included. However, over the longer term, we expect domestic investors will own more of their local markets given pension reforms and more wealth accumulation, on the back of the rising middle class and income growth,” the chief investment officer of Fidelity said.
Still there at 32 percent
Foreign ownership of KOSPI stocks have been going up and down, but it has been on a gentle downward slope since 2004 when it peaked above 45 percent (see graph). Now, foreigners hold about 32 percent of shares listed on the KOSPI market.
This is still a large foreign ownership compared to that in other Asian nations. In mainland China, for example, the portion of foreign holdings is less than 2 percent, so the country wasn’t shaken very much by the recent turmoil in Europe and the U.S. Compared to that, Korea has one of the most vulnerable financial markets to external shocks.
“Korea is a manufacturing-intensive export-oriented economy with no meaningful natural resources to speak of. As a result it is heavily exposed to changes in global demand, supply and commodity prices. Additional to that, it has some of the largest, most liquid and most open markets in the region so see greater capital mobility,” says Cochran of CLSA.
Surprisingly, the proportion of foreign holdings in Korea has yet fallen that much during this month’s sell-off.
Foreigners sold 5.07 trillion won worth of shares over nine trading days between August 2 and August 12 and their share remains almost unchanged. On Aug. 2 foreign investors in total had 32.10 percent of KOSPI, and on Aug. 11, 31.7 percent. This almost flat mvoement was because the market capitalization as a whole has decreased from 1,200 trillion won to 1,026 trillion won in the same period, in tandem with foreigners’ selling spree.
Back in the 2008 crisis, things were different. At the time, foreigners sold at a more rapid pace during the market crash following the bankruptcy of Lehman Brothers, and their collective ownership in the KOSPI market decreased from 34 percent to 28.7 percent that year.
What makes 2011’s Korea more stable in terms of foreign ownership percentage then in 2008? Fidelity’s Ford says that investors are looking at the bigger picture this time that the whole global economy is gradually shifting toward the East. Considering the role of East Asia in manufacturing and trading, the region is seriously underinvested in their portfolios so global investors are reluctant to leave even when they had to sell some stocks, he said. This is especially true for countries other than Japan, he said.
According to the IMF, U.S. investment portfolios on average only have 1.7 percent of their international exposure allocated to Asian equities compared with 6.8 percent in Japan. Likewise, European portfolios have just 2.2 percent in Asian equities versus 9.4 percent in the U.S.
“This underinvestment is unlikely to last as vastly superior economic growth prospects in the region make the region a preferred asset class in the medium to long term,” Ford said, adding that the recent downgrade of U.S. government debt by Standard & Poor’s “may prove to be a boost for emerging Asian market equities, given the attractive valuations and relatively strong fundamentals.”
Another difference from 2008 and 2011 is that the national economy is less dependent on developed markets. Morgan Stanley analyst Sharon Lam says that Korea has successfully shifted its export focus away from developed countries, and it now sells 60 percent of its exports to emerging markets compared to only 45 percent 10 years ago. “Thus, the slowdown that is concentrated in developed markets should have less impact on Korea now,” she said.
Patriots, or opportunists
The balance between foreign and domestic investors can develop into a nationalism issue. Nationality should hardly matter when profit is at stake in the globalized world of investment. Actually in many cases offshore funds that are counted as foreign investment in KOSPI’s categorization are made up of Korean investors' money. And it is practically difficult to draw a clear line between foreign and local institutional investors because in most cases they are entangled with each other in the web of global finance system.
Nevertheless, last week, headlines of some newspapers and news agencies in Seoul described the current situation by using terms from the 19th century history when Western imperial navy forces first reached Korea.
“A rifle infantry” of Korean retail investors fought bravely amid a massive sell-off bombing by foreign invaders, a typical headline would have read last week. And in defending the national stock market, the foot soldiers were supported by periodic cover firing from “machinegun squadrons” of national pension funds and government-owned funds.
Thursday saw the pinnacle of the foreigners vs. Korean retail investors battle. While the former group net sold 1.28 trillion won in shares — the second largest amount in history —, the latter group set their own record of 1.55 trillion won of net purchase, according to Korea Exchange, the trading bourse.
Usually, non-professional retail investors fell easy prey to institutional investors in this kind of volatile market because they lack information and the ability to remain cool. But this time it is hard to know who the winner is, since the worst of the market crash seems to have been averted, albeit fears remain.
The retail investors also have plenty of ammunition ready to buy more shares if prices fall further. According to the bourse, the net cash reserve in the retail investors’ accounts soared from 18 trillion won on Aug. 3 to a record-high of 22.6 trillion won on Aug. 10, which was enough to dwarf the foreign selling.
Pension funds, including the 340-trillion-won National Pension Service (NPS), are also believed to have joined the presumable bargain-hunting. Some analysts suspect that they moved on the orders of the government. But Lee Sang-che, standing commissioner of Financial Services Commission, the regulator, said that there was no such order and the funds reacted on their own judgment.
Time to bargain hunt?
The NPS alone owned some 60 trillion won worth of shares in KOSPI at the end of June, and its investment guideline allows the fund to buy as much as an additional 15 trillion won worth of shares when equities are believed to be underpriced. And now is such a time, says Ford of Fidelity.
“Asian stock valuations — already at multi-year lows — have become cheaper still, and at these levels there are many stocks which look attractive on any valuation measure, even allowing for the prospect of slower than previously hoped for economic growth in Asia as developed economies are forced to tighten their fiscal belts,” he said.
CLSA’s Cochran was optimistic, too. But he wasn’t sure about the timing to shift from sell to buy. In the short term, traders should be looking for oversold stocks with strong balance sheets to play a bounce, and long term investors should be deploying some capital now given the improved valuations, he said.
However, “the real test for this market will be if it can rally back through the 200-day moving average,” he said. “At this point I am not convinced we can rally through and sustain levels above the 200-day moving average. But as always, I will remain open-minded and respond to the market data and signals as they come to me.”