Photographer: SeongJoon Cho/Bloomberg

Foreigners Are Buying Korea Small-Caps at Fastest Pace on Record

  • Overseas funds encouraged by government’s small-firm reforms
  • Kosdaq lags behind benchmark Kospi, which is at a record high

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After being unloved for the past two years, South Korea’s small-cap Kosdaq shares are coming back in vogue.

Overseas investors, encouraged by the new government’s push to support small- and medium-sized companies have added a net 1.5 trillion won ($1.3 billion) worth of small-cap shares since Feb. 1, the most for any comparable period since 2005, when Korea Exchange began to keep records. The influx came even as the Kosdaq index underperformed the nation’s benchmark Kospi.

"South Korea’s small-caps have been ironically neglected while other smaller markets have rallied this year," Seoul-based Jung Sung-Han, a fund manager at Shinhan BNP Paribas Asset Management, said in a phone interview. “We now see details from the new administration’s policy to support SMEs, which will boost margin growth."

South Korean President Moon Jae-in has pledged to focus on smaller enterprises to help meet a goal of creating 500,000 jobs in the private sector, while committing to breaking the influence of conglomerates known as chaebols that have dominated the economy. A positive economic backdrop may offer space for reform: exports have been climbing for several months consumer confidence is up and the central bank has boosted its growth forecast.

The export gains have benefited the chaebol, in turn helping propel a 21 percent rally in the Kospi index this year. The gauge of 1,215 small-caps has advanced 7.3 percent. Behind the underperformance: industries such as cosmetics and tourism as well as K-pop shares were hit by the geopolitical tensions between South Korea and China over the U.S.-led deployment of an anti-missile defense system, leading to China curbing travel to its Asian neighbor.

That pushed the ratio of the MSCI Korea Small Cap Index -- which has 335 equities listed both on the Kospi and Kosdaq -- to the MSCI Korea Large Cap Index to a record-low last week, according to data compiled by Bloomberg.

Heo Pil-Seok, chief executive officer at Midas International Asset in Seoul, is cautious about the latest Kosdaq rally, saying that the earnings growth of South Korean large-caps hasn’t fully been taken into consideration. The 12-month forward price-earnings ratio for the Kospi has been below 10 times since January, the lowest since 2014.

"Kosdaq equities always rally once or twice a year," Heo said. "The Kospi index could rise up to 20 percent as earnings growth has not been priced-in yet."

Even so, overseas investors added holdings of 193 billion won worth Kosdaq shares last week, while they sold a net 11 billion won worth Kospi shares in the period.

Earnings on the 761-member Kospi gauge are estimated to jump 75 percent in the next 12 months, compared with 17 percent for the MSCI Asia Pacific Index, according to data compiled by Bloomberg. Earnings of Kosdaq-listed companies are expected to hit a record high of about 13 trillion won in 2017, according to emailed statement from Korea Exchange.

"Now it is time for small-caps to rebound," said Lee Chaiwon, chief investment officer at Korea Value Asset Management, by phone. "Tech and cyclical stocks, which led the Kospi index to rally this year, seem to be finding it hard to rise much further from the current level." The Kospi closed at a record-high on Monday, while the Kosdaq was at its highest since October.

— With assistance by Kyoungwha Kim, and Jonathan Annells

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