This ETF tracks the MSCI Korea Total Return Net Index, a free-float market-cap-weighted index with 115 constituent stocks as of October 2018, covering 85% of the Korean equity universe. Component stocks have to fulfill MSCI's size, liquidity, and free-float criteria to be included in the index. MSCI uses the official exchange closing prices to calculate the index's value. The index is reviewed on a semiannual basis, with minor quarterly reviews to accurately reflect the evolving marketplace.
The index is top-heavy. The 10 largest constituents account for 53% of its total market cap. The index has significant sector- and single stock-level concentration. The technology sector accounts for 41% of the index's value. Technology giant Samsung Electronics and preferred shares account for 31% of the index’s portfolio. Other major sector weights include financials (13%), consumer discretionary (10%), industrials (9%), and materials (7%). Aside from the heavy weight in Samsung Electronics together and SK Hynix, stock concentration is minimal. None of the remaining 112 stocks has a weighting greater than 3%.
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The fund levies an ongoing charge of 0.74%. While this is cheap relative to active funds in the Korea equity category, it is expensive compared with its passive peers. ETFs tracking MSCI Korea Index levy total expense ratios ranging from 0.60% to 0.74%. By way of comparison, the active funds' share classes charge between 0.91% and 1.98%.
This fund's annualised tracking difference (fund return minus index return) during the past three years was negative 0.64% for the period ended October 2018. As such, the index lagged its benchmark by an amount lower than its ongoing charge of 0.74%. BlackRock mitigated this fund's tracking difference with securities-lending revenue.
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The fund uses full physical replication to track the MSCI Korea Net Return USD Index. It also uses futures for cash management purposes. This is standard practice and helps limit tracking error.
IShares engages in securities lending and can lend up to 100% of the securities within this fund to improve its performance. The gross revenue generated from this activity is split 62.5%/37.5% between the fund and the lending agent BlackRock, whereby BlackRock covers the costs involved.
The fund lent out 17.99% of its assets on average and a maximum of 36.43% during the 12 months as of 30 September 2018, generating a 0.14% return.
To protect the fund from a borrower's default, BlackRock takes collateral greater than the loan value. Collateral levels vary between 102.5% and 112.0% of the value of securities on loan, depending on the assets provided by the borrower as collateral.
Additional counterparty risk-mitigation measures include borrower default indemnification. Specifically, BlackRock commits to replace the securities that a borrower would fail to return. The indemnification agreement is subject to changes, and in some cases without notice.
IShares holds a dominant position in the European ETF marketplace by virtue of its comprehensive offering. The fund management process is robust. We value the wealth of experience of the people behind it and the extensive internal network supporting the operation. Having said that, we take the view that the vast economies of scale generated by the BlackRock group could be better shared out with investors in the shape of lower ongoing charges.
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IShares MSCI Korea tracks a broadly representative benchmark, but its single-stock and sector-level concentration, compounded by its expensive ongoing charge, limit its Morningstar Analyst Rating to Neutral.
The MSCI Korea Index consists of 115 large- and mid-cap stocks, which cover approximately 85% of the Korean equity market. The technology sector accounts for almost half of the index's total weight, while the top 10 constituents represent 53%. Samsung Electronics, the fund's largest holding, accounts for approximately 27% of the total portfolio.
In terms of performance, the exchange-traded fund has landed in the first/second quartiles on a three-, five-, and 10-year risk-adjusted basis relative to its active and passive peers in the Korea equity Morningstar Category. Meanwhile, the fund's Sharpe ratio has been higher given that it has exhibited comparable volatility to its category peers during that period.
With an ongoing charge of 0.74%, this ETF is one of the most expensive passive funds that offer exposure to Korea equities. However, its higher cost has not had an impact on its benchmark-relative returns. The fund's tracking difference (fund return less index return) has been competitive relative to its ETF peers tracking the same index, helped by securities-lending revenue.
Because of its heavy concentration at the sector and stock levels, this fund doesn't represent a compelling long-term investment proposition, limiting its Morningstar Analyst Rating to Neutral.
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Korea's economic growth has been relatively steady in the past few years. The country's gross domestic product growth rates in 2016 and 2017 were 2.8% and 3.1%, respectively. Meanwhile, the Bank of Korea expects economic growth to maintain a similar pace, projecting 2.7% growth in both 2018 and 2019 (as of October 2018). The Bank of Korea raised interest rates by 25 basis points in November 2017 from record low levels and hiked them another 25 basis points in November 2018 to 1.75%. It is worth noting that, because of its export-driven nature, Korea's economy will likely be sensitive to changes in global economic conditions. Investors should also be mindful of the potential for escalating political and military tensions between South and North Korea--which tend to have a negative impact on South Korea's financial markets.
Samsung Electronics accounts for 27% (or 31% together with its preferred stock) of the ETF's portfolio--by far its largest holding. This technology giant (manufacturer of consumer electronics, mobile phones, memory chips, and LCD panels) was the world's largest smartphone maker with a 20% market share, followed by Huawei at 15% and Apple at 13% as of third-quarter 2018, according to IDC. Competition in the smartphone space has been intensifying during the past three years. Morningstar equity analyst Kazunori Ito assigns the stock a Morningstar Economic Moat Rating of narrow (as of 12 June 2018). Ito believes that Samsung's leading position in the memory market constitutes an economic moat, despite the commodity nature and high cyclicality of the business. Technology stocks (under the new GICS classification) account for 41% of the ETF's portfolio.
Financials represent the fund's second-largest sector exposure, accounting for 13% of the portfolio. This consists of banks, securities, and insurance firms. The main components within the financial sector are KB Financial Group (3%) and Shinhan Financial Group (2%). High household debt levels are a key risk facing the Korean financials sector. Household credit outstanding grew by 7% on a year-over-year basis in the third quarter of 2018.
Consumer discretionary is the ETF's third-largest sector exposure, accounting for 10% of its portfolio. This segment consists largely of carmakers and related business. The largest single stocks represented are Hyundai Motor (2%) and Hyundai Mobis (2%). Sales for these companies are highly export-driven.
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This ETF is domiciled in Ireland and is listed in various exchanges in Europe. Xtrackers MSCI Korea UCITS ETF is listed in Hong Kong, Singapore, and various exchanges in Europe. The fund carries a total expense ratio of 0.65% and is also rated Neutral. It employs full physical replication. Lyxor UCITS ETF MSCI Korea (listed on various exchanges in Europe; 0.65%) is also rated Neutral and showed fairly similar historical performance as the Xtrackers ETF, while the Lyxor ETF employs synthetic replication.
Within the Korea equity category, there is a single Morningstar Medalist, JPM Korea Equity, rated Bronze.
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