Korean retail investors are in the global spotlight due to volatility stemming from the potent mix of the semiconductor sector boom and leveraged exchange-traded funds (ETFs).
After breaking the 9,000-point mark, Korea’s main bourse KOSPI index has now corrected to 6,000, causing much angst among retail investors, with losses likely to be much greater for those invested in leveraged ETFs. Right on cue, China delivered another “DeepSeek moment” when Chinese startup company Moonshot revealed a model that claims to be on par with recent models from OpenAI and Anthropic. Just as sentiment on artificial intelligence (AI) is fading (for the time being), the news is likely to cast further uncertainty over the entire AI sector and, in turn, the semiconductor-heavy Korean stock market.
The Korean regulators have unintentionally let a genie out of the bottle by introducing single-stock leveraged ETFs, causing the steroids-induced volatility. Previously, leveraged ETFs tracking the broader KOSPI index were available, which were much less volatile. The extreme volatility has prompted Korean regulators to announce a policy on July 17 to stabilize the increasingly untenable situation, even for ultra-aggressive Korean retail investors. The dramatic reversal of sentiment in the semiconductor sector has highlighted to the world the dangers of using ETFs to move away from indexing toward not just active, but leveraged products that mimic the exotic derivatives once available only to strictly institutional investors.
Korean regulators allowed leveraged ETFs to satisfy increasingly speculative retail demand, leading to a wave of outbound fund flows into U.S.-listed ETFs. Much of the explanation for the weakening of the Korean won is linked to Korean retail investors moving into U.S. stock markets via the so-called “Magnificent Seven” stocks and leveraged ETFs. The move has backfired spectacularly, not only due to the ensuing volatility but also because its introduction runs counter to current market reform efforts to make the Korean equity market more stable, mature and transparent. The Korean stock market is once again at a crossroads, trying to introduce a long-term investment culture to a nation with deep speculative, momentum DNA.
There are various reasons why Koreans are leading this phenomenon. One of the underappreciated reasons for the fabled “Korean discount” is the inherently short-term and speculative investment culture among Koreans, both institutional and domestic. The lack of a long-term investment approach originates from Korea’s industries being built on an aggressive, cyclical business foundation. In the early years of Korea’s industrialization, this aggressive mindset served the nation well, helping it catch up to other manufacturing economies and expand its export footprint. The focus on sales growth, aggressive capital expenditures strategies and balance sheet expansions of its exporters was considered the primary factor behind the focus on growth over profits, thus the valuation discount on Korea Inc.
But as the Korean economy matures, this approach is increasingly becoming a handicap rather than a weapon. Previously, calls for structural reform to prioritize shareholder returns were ignored by the Korean government, corporations, and even investors. The market reform currently underway, with an emphasis on return on investment and other fundamental metrics, was first initiated just over two years ago. Significantly and surprisingly for many, it is the first time such reform has been a top policy priority for any Korean government. For the first time, the Korean government, with the backing of the domestic investment community, acknowledged the need to prioritize stable, sustainable growth over short-term trading by encouraging dividends and enhanced corporate governance.
Amid the positive structural trend, the emergence of leveraged ETFs has enabled concentrated bets by retail traders, amplifying perceptions of a market bubble and its imminent bursting. The dramatic correction in the sector can be explained for the most part by retail-driven volatility fueled by leveraged ETFs. The ballistic rise of the chip sector and the ensuing volatility have raised concerns about a bubble that could burst the exuberance as quickly as it formed. Korean retail investors have led the global trend of the retail investor population migrating from small caps to thematic ETFs. Since the beginning of this year, speculative traders have overwhelmed the steady flow of long-term investors by chasing momentum behind the semiconductor theme.
Leveraged ETFs are just another challenge for Korea’s road to fostering a long-term investment culture, as ETFs in general are a double-edged sword of being a tool for further speculation or a long-term buy-and-hold culture. The long-term money that the Korean government is trying to attract was based on dividend yields and sustainable support for minority shareholders. The mission for Korean households to reduce their heavy reliance on apartments and increase equity ownership will be a long-term trend and an inevitable outcome for a rapidly shrinking population. However, ownership of equities via leveraged ETFs runs counter to that mission, as speculative traders stand to undermine the long-term investment culture. The current market volatility is just another lesson for Korean investors on their way to developed economy mindset.
Peter S. Kim is a managing director at KB Securities and KB Financial Group.