Big investors think it might be time to buy in South Korea
In a sign of the shift in mood, foreign investors turned net buyers of South Korean shares, purchasing a record 7.2 trillion won ($5 billion) worth of stocks on Friday.
Global investors pulled back from South Korean stocks through a wild turn in July but are keeping faith with the heavyweight chipmakers on the view that their growth momentum is intact, while leveraged holdings that rocked the market may have thinned out.
In a sign of the shift in mood, a record rally on Friday showed foreigners, who have been net sellers of South Korean shares all year, turned buyers of 7.2 trillion won ($5 billion) worth of stock, more than double the previous one-day record.
The sanguine mood contrasts with anger among domestic retail traders, burned by a roughly 40% drawdown from a peak in June.
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Assets at leveraged exchange-traded funds (ETFs) with Korean underlying stocks Samsung Electronics and SK Hynix have collapsed from $50 billion in late June to $17 billion last week, according to JP Morgan research.
"This was a leverage event, not an earnings event," said Steve Lawrence, chief investment officer of US-based Balfour Capital Group.
"I'll say it plainly: I'm a bull on Samsung here. It got sold for carrying half the index's weight, not for anything in the business," said Lawrence, who manages over €400 million.
"The memory cycle and the AI capex story are intact, and the unwind is handing it to you at a discount the fundamentals don't justify."
Analysts said the market drop was aggravated by forced selling of shares at haemorrhaging hedge fund Situational Awareness, which also now appears to be over, after Citadel bought the bulk of the fund's remaining equities book.
Samsung shares almost halved in value from a peak in June to a trough late in July, despite the company reporting a 250-fold increase in chip profit and solid outlook on the back of demand from data centres.
Shares in rival SK Hynix have followed a similar pattern, with both rebounding sharply in a volatile session on Friday.
Average allocations to South Korea by active global emerging market funds rose sharply over 18 months but flattened in June, as volatility spiked, figures from analytics firm EPFR show.
"In Korea, we believe the leveraged ETF unwind is complete and hedge funds are ~90% through deleveraging – back to acceptable levels," according to JP Morgan analysts led by Rajiv Batra, head of Asia and co-head of global emerging markets equity strategy.
"If a durable bottom forms here, history is supportive," they said in a note in July, with the median 12-month return after previous emerging-market corrections being about 28%.
'Accident waiting to happen'
Leverage has been at the forefront of South Korea's sparkling rally and stunning reckoning because, via products such as single-stock leveraged exchange-traded funds, it has transformed the market and jacked up volatility.
The rally that more than tripled the value of the KOSPI benchmark over the 12 months to June's peak hit overdrive after single-stock leveraged ETFs launched in South Korea in May and they exacerbated the slide from the highs.
"Long only investors just don't want to have to manage positions in stocks which are moving as violently as these stocks are moving," said William Brattan, head of cash equity research for APAC at BNP Paribas.
The extremely sharp drop led to a public apology from South Korea's Finance Minister Koo Yun-cheol for introducing these ETFs without careful consideration, and new measures to rein in the leveraged products.
Citi's trading strategies desk estimated last week total losses for retail investors in leveraged ETFs at around $38.7 billion, a factor in mounting anger directed at policymakers for allowing single-stock leveraged funds to launch.
"The amount of money that went into SK and Samsung was staggering," said Pierre Hoebrechts, deputy CIO at East Eagle Asset Management.
"The number of accounts opened in Korea, combined with local leverage and very concentrated exposure, with the cherry on the cake being large 2x-levered foreign ETFs, just made it an accident waiting to happen."
Hoebrechts said his firm had been short, or betting on falls in the KOSPI and Japan's Nikkei since the end of June, but squared off its positions last week, believing the washout phase may be nearing an end.
Average short interest, weighted by positions' value, for South Korea is about 4.3%, down from a recent peak of about 5.3%, according to data from S3 Partners.
To be sure, there are plenty of risks remaining, and for many, Friday's record-breaking 17.9% surge in the KOSPI was just as unsettling as some of last month's sharp falls. The index fell nearly 5% on Monday.
But, said Larry Hatheway, head of research at Franklin Templeton Institute, US institutional investors, while wary of stepping into a falling market, "may be willing to take another look at some of these (Korean) names now."
