November 4, 2012 4:06 am

Regulator probes South Korea’s small cap boom

Ahn Cheol Soo©Bloomberg

Smaller company shares are enjoying a rare boom in South Korea’s stock market, which has been dominated by big exporters, amid hopes that small and mid-sized enterprises would benefit from the growing political pressure on family-run conglomerates ahead of December’s presidential election.

With the absence of clear market leaders amid the uncertain global economic outlook, investors are increasingly shifting their attention to small information technology and biotechnology companies, entertainment-related groups and election-driven stocks.

They are moving away from traditional manufacturing powerhouses such as Samsung Electronics and Hyundai Motor.

Trading volumes for companies outside the top 300 stocks have exploded to the highest level in at least 12 years as presidential candidates promise to support SMEs and crack down on the big family-run conglomerates under the catchy slogan of “economic democratisation”.

Some 77bn shares on the Kospi Small-Cap index were traded so far this year (as of October 23), surpassing any full-year volume since 2000 when the Korea Exchange started unveiling the data.

Some of the country’s small-cap focused equity funds have posted investment returns of more than 20 per cent so far this year.

The Kospi Small-Cap Index, made up of 464 companies that fall outside the 300 biggest listed groups in terms of market capitalisation, has risen about 7 per cent over the past two months, even as the Kospi Large-Cap Index of the country’s top 100 companies has fallen 1.7 per cent. The country’s junior Kosdaq market has also risen about 10 per cent in the past three months.

Notably, shares of Nexen, a maker of tyres and rubber inner tubes and one of the larger constituents of the small-cap index with a market value of Won432bn ($396m), have jumped nearly 60 per cent over the past six months.

Sunny Electronics, a maker of components for computers and mobile phones, has performed better still amid the election fever.

The shares have surged more than 10-fold to Won4,190 so far this year, mainly because its vice-president previously worked for Ahnlab – an anti-virus software company founded by Ahn Chul-soo, an independent presidential candidate – although the company has posted losses since 2010.

“Investors are seeking alternative investment targets as stocks of big companies have showed a lacklustre performance in recent months,” says Oh Seung-hoon, an analyst at Daishin Securities.

“With the economic democratisation movement focusing on two issues – chaebols’ corporate governance and SMEs’ growth – we can say that an investment environment positive for SMEs while negative for big companies has been created.”

In this election season, the need for a more dynamic small-business sector has become one of the dominant campaign themes amid growing concerns that the chaebols’ economic dominance is stifling growth of SMEs as the big companies tower over almost every area of business.

Politicians have promised to pare back the dominance of the chaebol, by cracking down on the complex cross-shareholdings between subsidiaries that give the founding families undue influence, while propping up SMEs, which account for 90 per cent of jobs, by expanding easy credits for them and barring chaebol companies from entering specific business areas.

Such election pledges and vague hopes for benefits to companies with political ties have prompted retail investors to snap up the so-called politically themed stocks in the past year. But their gamble threatens to turn into a disaster as the bubble starts to pop with the December election nearing.

The country’s financial watchdog has said that about 1.95m Korean investors have suffered a combined Won1.5tn of losses by investing in 35 election-themed stocks, even though their prices rose by an average 93 per cent during the year to June 2012.

AhnLab itself is a prime example. The shares have endured a rollercoaster ride in the past year, surging more than five fold from Won30,000 in September 2011 to around Won160,000 in early January but falling back about 60 per cent since.

EG, a chemical company owned by Park Ji-man, the younger brother of the ruling party’s presidential candidate Park Geun-hye, is another example.

Its shares have risen about 70 per cent to Won41,000 over the past year although they are now trading at half their January peak of Won80,700.

The outsized gains in such election-driven stocks have prompted the Financial Supervisory Service to set up a taskforce to look into speculative forces alleged to be manipulating share prices.

The FSS has also introduced measures to protect retail investors by halting trading in some “dangerously overheating” stocks for a day and regulating their trading prices for three days.

Despite the correction in some overheating stocks, analysts expect the small-cap rally to continue for some time, with investor interest in politically themed stocks likely to last at least until the election day.

“They are not driven by fundamentals, but by expectations for a political event, which is totally unpredictable,” says Lim Soo-kyun, an analyst at Samsung Securities.

“Some of the small-cap shares such as IT parts makers and tour agencies relying on Chinese tourists have a real growth story but most of them are overshooting their fundamentals. Investors need to be careful as a bubble is bound to pop.”

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