FLKR - Franklin FTSE South Korea ETF: Flicker Of Hope

Summary

• The Franklin FTSE South Korea ETF is a smaller, less commonly covered ETF that tracks the performance of mid/large cap stocks in South Korea.
• South Korea is currently my top pick out of the top five largest MSCI Emerging Market countries, which include China, Taiwan, South Korea, India, and Brazil.
• The market still trades slightly below book value and at around 10x P/E, although many of the stocks are IT and consumer stocks.
• 2023 is an excellent year to continue accumulating Korean equities, as macro headwinds this year could create solid entry points.

Overview

The Franklin FTSE South Korea ETF (FLKR) is a smaller, less commonly covered ETF that tracks the performance of stocks in South Korea.

As you can see, this ETF moves in line with the larger iShares MSCI South Korea ETF (EWY), although these ETFs have some notable differences. South Korea equities also closely track emerging market stock performance, as this index has only outperformed the iShares MSCI Emerging Markets ETF (EEM) by around 3 percentage points since its inception. South Korea is currently my top pick out of the top five largest MSCI Emerging Market countries, which include China, Taiwan, South Korea, India, and Brazil.

The market still trades slightly below book value and at around 10x PE, despite its higher weighting in IT and consumer stocks (45% IT stocks, which is notably higher than the 19.62% MSCI weighting). 2023 is an excellent year to continue accumulating Korean equities, as macro headwinds this year could create solid entry points. The Franklin FTSE South Korea ETF is a solid investment vehicle to consider in lieu of other Korean ETF products, mainly because of its lower management fee. However, this is a passive investment vehicle, and its performance will move in line with other ETFs. Investors could potentially outperform by investing in ADRs or other closed-end funds.

ETF Overview

This ETF tracks the performance of large caps and mid-caps in South Korea, which largely consist of IT and consumer stocks. At the moment, South Korean equities trade at 9.8x earnings and at 0.9x book value.

The market can be accessed at even lower valuation by investing in other types of themes including banking and basic materials companies. Most Korean banks trade well below book value, but only 10% of the MSCI Korea Index consists of financial companies.

Other leading companies like POSCO (PKX) also trade at a historical discount (circa 4-5x earnings as well)

If you are investing in ETFs like this, then you can access Korea's stock market at a considerable discount to MSCI Emerging Markets, while also accessing industries that typically command a premium to the overall index. A quick glance at Korean materials and financial stocks shows how cheap the market is at the moment.

This ETF has several differences relative to other larger ETFs and closed-end fund products:

• Extremely low fee : The management fee is only 0.09% , relative to over 50 basis points for larger ETFs and over 1% for closed-end funds. The iShares MSCI South Korea ETF charged a 0.58% fee .
• More Holdings : This ETF invests in more companies (166).
• Valuation : Based on the latest data, this ETF trades at a considerable discount to the index.

These differences lead me to prefer this ETF over the iShares MSCI South Korea ETF. The fund's smaller size is not a concern for me, as funds that are liquidated typically have much smaller AUM ($50mn or smaller) and invest in much riskier markets (i.e. Central Asia). One does not have to worry about this fund drastically underperforming the index, as its industry composition is very similar to the MSCI South Korea Index.

There is no real reason to pay the higher management fee of over 0.5% for an ETF.

This is why this ETF is the best bet for passive investors who want exposure to South Korea and are not concerned about making strong industry bets.

One distinguishing factor is that Samsung (SSNLF) makes up a larger % of the MSCI South Korea Index. Moreover, this index only includes 102 companies, while this ETF invests in over 160 South Korean stocks. These small differences lead to relatively lower valuation and product differentiation, even though it is still a passive vehicle.

South Korea Macro Risks

A lot of regional countries like South Korea and Taiwan have struggled due to lower global demand for electronics. On the other hand, China's reopening and economic turnaround could also help to boost global electronics demand. Over 25% of South Korea's exports go to China, so this should significantly impact the economy.

Growth should rebound slightly from the low of Q4 2022:

• South Korea's economy contracted by 0.4% during Q4 2022 due to a combination of weaker exports and monetary tightening. Semiconductor exports declined by 44.5% YoY in January 2023.
• Exports currently account for 35% of GDP, and its main export markets are China, the United States, and Europe (nearly half of its total exports).
• Growth will also likely decline further due to deleveraging and the Central Bank hiking rates in subsequent quarters this year.
• The economy faces a combination of headwinds and tailwinds, as China's reopening may be balanced with slower growth in its other export markets.

Global electronics demand should recover in subsequent quarters, which could help boost the economy.

Other Ideas

This ETF is likely the best option for investors who have limited exposure to emerging markets and do not want to actively bet on certain sectors of the South Korean economy.

Closed-End Funds : The Korea Fund (KF) is likely a better investment vehicle to accumulate during any drawdowns experienced this year due to slower electronics demand. The fund currently trades at a 12% discount to NAV , but this discount could increase to 15-20% in 2023.

This fund was able to outperform the iShares MSCI South Korea ETF by over 10 percentage points during the past three months. This displays how this fund can be a solid vehicle to accumulate during darker times when the discount to NAV expands. However, the current discount of 12% is near its historical average and not that impressive.

Banks : South Korean banks are trading at nearly 1/3 of book value, and this is one of the clearest ways to access South Korea's stock market at a discount.

These banks typically trade well below book, but both still trade at a historical discount.

Leveraged ETFs : Since South Korean stocks have been very volatile in recent months due to weaker semiconductor demand, leveraged ETFs could be a solid option for short-term trading. I typically avoid these products, but the opportunity in South Korea is intriguing as there are not any long-term issues with the economy and stock market in my view. Leveraged ETFs are designed to provide leveraged exposure (3x) to the daily performance of the index. While these products can produce stellar short-term gains if you time everything perfectly, there is a huge risk associated with these products. If you purchase these products before the market declines, it can be very difficult to recover your principal, as the products will decline 3x faster than the index. These products are only suitable for short-term trading.

This Direxion Daily South Korea Bull 3x Shares ETF (KORU) more than doubled from its November lows.

However, if you time things poorly and hold these products for a long time, you can lose a large % of your principal investment. Investors should be prepared to cut their loss days or weeks after initiating a position if the index begins to decline.

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