South Korea ETFs Soaring Despite Looming VWO Sales

ETFs tracking South Korean equities are defying logic these days. With the Vanguard MSCI Emerging Markets ETF (NYSE:VWO), the largest emerging markets ETF by assets, poised to drop the MSCI Emerging Markets Index next year in favor of the FTSE Group equivalent, some analysts and investors expected a sell-off in South Korean stocks.

The reason being because the FTSE Emerging Markets Index does include South Korea as a developing nation. That means Vanguard, the third-largest U.S. ETF sponsor, will have to dump South Korean equities as VWO transitions to the FTSE index. As of the end of October, South Korea accounted for 15.3 percent of VWO's weight.

VWO currently holds shares of industrial conglomerate Samsung, the fund's largest holding, automakers Hyundai and Kia and steelmaker Posco (NYSE:PKX) among other South Korean stocks.

Despite assurances from Vanguard that its index transition will be efficient, gradual and orderly, there has been ample speculation South Korean stocks will come under pressure due to the switch.

That is not happening. At least not yet. It is not unreasonable to say nearly everyone that follows ETFs and nearly everyone that follows South Korean stocks knows Vanguard has to sell Samsung, Kia and friends. Vanguard announced the index switch on October 2. Since then, the $3 billion iShares MSCI South Korea Index Fund (NYSE:EWY) is fractionally lower.

EWY's loss is nothing to complain when noting the aforementioned four stocks combine for 34.3 percent of the fund's weight. All four are found among EWY's top-10 holdings. Alone, Samsung accounts for 22.2 percent of EWY's weight.

Perhaps even more impressive is the fact that over the past month, EWY has shown no ill-effects of the Vanguard change as the ETF has gained 3.1 percent.

EWY is not alone. Unbeknownst to many investors, there is another South Korea ETF on the market, the First Trust South Korea AlphaDEX Fund (NYSE:FKO). Unlike EWY, the First Trust South Korea AlphaDEX Fund is not traditional market cap-weighted ETF. Rather, FKO uses growth and value factors such as sales to price and one year sales growth, book value to price, cash flow to price and return on assets to screen for possible constituents.

Not surprisingly, FKO has few stocks than EWY (50 for the former compared to 107 for the latter). FKO also offers a more balanced approach as no single name represents more than 4.5 percent of its weight. The first trust offering has also proven nearly immune to the Vanguard news, rising four percent since October 2. Like EWY, FKO has also held up nicely over the past month, gaining 2.9 percent.

At this juncture, it looks like it is safe to say that the Vanguard-induced buying opportunity in South Korean stocks some investors were clamoring for in October will not materialize because, well, Vanguard is not going to induce it.

Nor has Vanguard's index change for VWO lead to upside for Brazilian and Chinese stocks even though the ETF will have higher allocations to those nations upon transitioning to the FTSE Emerging Markets Index. In fact, those are the FTSE's index's two largest country weights.

Yes, the iShares FTSE China 25 Index Fund (NYSE:FXI) is up 5.3 percent since October 2, but that is more attributable to bullish Chinese economic data than Vanguard gobbling up Chinese stocks. Conversely, the iShares MSCI Brazil Index Fund (NYSE:EWZ) has slid 5.6 percent over the same period, indicating that neither Vanguard nor any other fund company have been able to stem the tide of slumping Brazilian equities amid that country's slack economic growth.

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