Global Investors Reassess South Korean Stocks After Leveraged ETF Collapse

Some global investors are beginning to see value in South Korean stocks after a period of extreme volatility wiped out months of gains. The market turmoil, largely attributed to the unwinding of highly leveraged investment products, has created what some view as a discount on market heavyweights like Samsung Electronics, despite their strong underlying performance.

A Market Shaken by Leverage

The recent downturn saw the South Korean market suffer a roughly 40% drawdown from its peak in June, severely impacting domestic retail traders. The sell-off was intensified by a massive deleveraging event, with assets in leveraged exchange-traded funds (ETFs) tied to Samsung Electronics and SK Hynix plummeting from $50 billion in late June to $17 billion last week, according to research from J.P. Morgan.

This rapid collapse led to forced selling and staggering losses for retail investors, which Citi's trading desk estimated at around $38.7 billion. The volatility was exacerbated by the introduction of single-stock leveraged ETFs in May, a move for which South Korea’s Finance Minister Koo Yun-cheol later issued a public apology.

Fundamentals vs. Market Mechanics

Several analysts and investors argue that the sell-off was a technical event, disconnected from the core business fundamentals of leading companies. "This was a leverage event, not an earnings event," said Steve Lawrence, chief investment officer of U.S.-based Balfour Capital Group. "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."

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Despite its shares nearly halving from their June peak to a July trough, Samsung reported a 250-fold increase in chip profit and provided a solid outlook driven by data center demand. This divergence between stock performance and corporate earnings is attracting institutional attention, evidenced by a record influx of foreign buying. On a recent Friday, foreigners purchased a net 7.2 trillion won ($5 billion) worth of stock, more than double the previous one-day record.

Cautious Optimism Ahead

Analysts at J.P. Morgan believe the deleveraging process is largely finished. "In Korea, we believe the leveraged ETF unwind is complete and hedge funds are ~90% through deleveraging," a team led by Rajiv Batra wrote in a July note. They added that historically, the median 12-month return after similar emerging-market corrections has been about 28%.

However, significant risks remain, and the market's recent volatility is a deterrent for many. The KOSPI benchmark's record-breaking 17.9% surge on Friday was followed by a nearly 5% drop on Monday, underscoring the ongoing instability. Still, some see the washout phase as nearing its end. Larry Hatheway, head of research at Franklin Templeton Institute, noted that U.S. institutional investors, while wary, "may be willing to take another look at some of these (Korean) names now."