Get pure Korea exposure with iShares

Last week the Bank of Korea cut interest rates by 25 basis points to 2.5 per cent. According to BlackRock, the rate cut had been well priced in, to the extent that the South Korean won strengthened following the news.

Analysts are now predicting that if growth were to weaken further, especially on the domestic front, another interest rate cut could be on the cards this year. The finance minister welcomed the central bank rate cut, as it follows a pro-growth expansionary approach from the government. This coordinated approach should help support domestic demand, which has been weak.

If you want exposure to South Korea in your portfolio, one way to do so is to invest in a South Korean equities exchange traded fund (ETF). There are 10 South Korean ETFs on the London Stock Exchange, but only two of them are physically replicated, which means they buy the underlying physical shares within the index they are tracking. db X-trackers and Lyxor run synthetic ETFs but their structures are very complex, which is why investors tend to prefer physical ETFs.

We like iShares MSCI Korea UCITS ETF (Inc) (IKOR), which is physically replicated. It has closely tracked its index, the MSCI Korea, closely over the past few years, and is relatively large at £300m in size. Over one year (to 18 August) the fund has returned 13 per cent, while it has returned 22 per cent and 64 per cent over three years and five years, according to Morningstar data.

HSBC also runs a physically replicated Korea ETF (HSBC Korea UCITS ETF (HKOR), which with a total expense ratio (TER) of 0.6 per cent, is slightly cheaper than iShares' offering, which has a TER of 0.74 per cent. But Peter Sleep, senior investment manager at Seven Investment Management, says its small size (at £3m in total) means it could be at a higher risk of closing in the near future, which would be bad news for investors with money in the fund.

The larger size of the iShares' MSCI Korea UCITS ETF (Inc) is also an advantage because it means it is more liquid, and therefore easier and cheaper to trade. The bid-offer spread (the difference between the sell price and the buy price) on IKOR is 0.16 per cent versus HKOR's 0.37 per cent, according to Lipper data (on 18 August 2014).

One potential downside to the fund is it that it is skewed very strongly towards Samsung Electronics. It has 25.3 per cent of its portfolio invested in the company in total, with 22 per cent in Samsung shares and 3.3 per cent in Samsung preference shares. Historically, Samsung's share price has performed strongly thanks to the success of its smart phones, but its price has weakened over the past two years. BlackRock has admitted that it poses a risk to investors as it "struggles to compete in the smart phone market".

This heavy allocation brings the ETF's total information technology sector exposure to around 38 per cent. So, investors who already have large amounts of technology companies, particularly in Samsung, in their portfolios should watch for overlap.

Another factor to consider is that South Korean companies tend to offer very low yields, so suit growth investors rather than those looking for income. The dividend yield on this fund is a tiny 0.08 per cent. But if you're looking for cheap exposure to a market that looks set for a boost, and can afford to take on the risk of owning a single country fund in your portfolio, this ETF looks like the best of breed. Buy.

Performance data for iShares MSCI Korea UCITS ETF (Inc) (IKOR)