Global institutional investors that pulled back from South Korean equities during July's tumult have shown renewed appetite for the market, focusing their allocations on the country's dominant semiconductor companies while leveraged positions that amplified the sell-off appear to be unwinding.
Foreign investors turned buyers in a dramatic session on Friday, net-purchasing 7.2 trillion won ($5 billion) of South Korean shares - a one-day inflow more than double the previous record. The move stands out against a backdrop in which foreigners had been net sellers throughout the year, and it reflects growing conviction among large managers that the underlying growth story for chipmakers remains intact.
The mood among global institutions contrasts sharply with the sentiment of many domestic retail traders, who experienced roughly a 40% retracement from a June peak. That sell-off included steep declines in heavyweight semiconductor names: Samsung Electronics shares fell by nearly half from June highs to a late-July trough, and SK Hynix saw a similar pattern, despite strong company-level profit and demand signals. Samsung's reported chip profit surged by a factor of 250, and its outlook was described as solid amid data centre demand, yet market moves were driven largely by mechanical selling rather than fundamentals.
"This was a leverage event, not an earnings event," said Steve Lawrence, chief investment officer of U.S.-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," Lawrence added, referencing the large index weight carried by the company. He manages over 400 million.
Part of the selling pressure has been attributed to highly leveraged products. Assets tied to leveraged exchange-traded funds (ETFs) linked to Korean stocks including Samsung Electronics and SK Hynix plunged from around $50 billion in late June to $17 billion in the most recent week, according to research from J.P. Morgan. That unwind intensified volatility and magnified both the initial rally to June's peak and the subsequent fall.
Analysts have pointed to forced selling tied to a hedge fund, Situational Awareness, as an aggravating factor in the market's descent. The forced liquidations reportedly have abated, after Citadel acquired the bulk of the hedge fund's remaining equities portfolio.
J.P. Morgan strategists, led by Rajiv Batra, noted in July that they believe the leveraged ETF unwind is finished and that hedge funds are largely through their deleveraging process - "~90% through deleveraging - back to acceptable levels." They suggested that if a durable bottom forms, historical patterns from prior emerging-market corrections could be supportive, with the median 12-month return after such corrections around 28%.
The role of leverage in both the rally up to June and the rout that followed has drawn intense scrutiny. The introduction of single-stock leveraged ETFs in South Korea in May is seen as a turning point - these products turbocharged gains on the way up and exacerbated the slide from the highs on the way down. The concentration of exposures, combined with heavy local participation and large 2x-levered foreign ETFs, heightened the risk of a violent adjustment.
"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.
South Korea's Finance Minister publicly apologised for the introduction of these ETFs without what was described as sufficient deliberation, and authorities have moved to implement measures aimed at reining in the leveraged products. Estimates from Citi's trading strategies desk put total losses for retail investors in leveraged ETFs at roughly $38.7 billion, a figure that has fuelled public anger and calls for tighter oversight.
"The amount of money that went into SK and Samsung was staggering," said Pierre Hoebrechts, deputy chief investment officer at East Eagle Asset Management. He pointed to the surge in account openings, pervasive local leverage, and concentrated exposures as ingredients of "an accident waiting to happen." East Eagle had taken short positions on the KOSPI and Japan’s Nikkei since late June but closed those positions last week, citing a belief that the washout phase may be ending.
Average short interest in South Korea, weighted by position value, has declined to about 4.3% from a recent peak near 5.3%, based on data from S3 Partners.
Still, risks remain. The market's recent spike - a record-breaking 17.9% surge in the KOSPI on Friday - was unsettling to some investors just as the prior sharp falls were. The index had also fallen nearly 5% on Monday, underscoring persistent volatility.
Despite the turbulence, some U.S. institutional investors are considering re-entry. "U.S. institutional investors, while wary of stepping into a falling market, may be willing to take another look at some of these (Korean) names now," said Larry Hatheway, head of research at Franklin Templeton Institute.
Average allocations to Korea within active global emerging market funds had climbed markedly over an 18-month period but levelled off in June as volatility spiked, according to data from analytics firm EPFR. Market participants will be watching whether foreign buying and the apparent completion of major deleveraging translate into a sustainable base for further gains.
Exchange rate noted in market reports was $1 = 1,442.0900 won.