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Korean Market's Drop Highlights Need for Reform, not Fundamental Flaws

This year's bear market is sentiment-based, rather than a precursor to another crisis.

Back to the Global Portfolio mailbag, this time looking at the Far East.


Gary Fendelander

writes that he "caught a brief interview with an international currency analyst on


, who said Korea would have to devalue

its currency." Obviously, this would have a serious impact on the Korean stock market, as well as others in the region. "I remember the last time this happened!" he says.

I didn't see that particular broadcast and Fendelander did not know the currency analyst's name so I don't know the context for those remarks or what was actually said. However, while the Korean stock market has had a horrible year, with the benchmark


index falling 39% since the beginning of the year, the fundamentals of the economy are strong. The economy should grow around 10% this year, inflation is low and, most importantly, there have been some significant steps toward restructuring the economy and businesses, untangling the anticompetitive relationships between the government and the


conglomerates. The bottom line: There is little chance of a repeat of the financial crisis of 1997.

Instead, the Korean market has been hurt this year by the feeling among both local and foreign investors this year that the government has slowed the pace of reform and the economy is due for a significant slowdown.

However, "There's nothing fundamental about

this year's selloff, it's just pure sentiment," says Mark Headley, portfolio manager of the

(MAKOX) - Get Matthews Korea Investor Report

Matthews Korea fund. "

The market is very cheap; earnings are very strong; the macro situation is pretty positive."

"People need to decide that Korea is going to move forward from here instead of falling off a cliff," says Headley, who believes that Korea has broken out of its historic economic boom-and-bust cycle, and will experience slower but still positive growth over the next year.

Feeling the claws of that bearish market, the Matthews Korea Fund is down 34% this year. Other Korea-only plays have also suffered: The

iShares MSCI South Korea

is down 22% since it was introduced in May. The three Korean closed-end funds have had equally dismal performances this year. The


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Korean Investment fund is down 25%. The


Korean Equity fund is down 24%, and the

(KF) - Get Korea Fund Inc Report

Korea fund is down 23%.

More bad news hit the Korean market on Friday with the announcement that


(F) - Get Ford Motor Company Report

had decided against making a bid for the troubled

Daewoo Motor

. Investors had viewed the proposed acquisition as a key step in Korea's restructuring process. The Kospi fell 3.4% Friday on the news.

"There has to be corporate restructuring and financial restructuring before Korea really turns around," says Charles Kim, vice president for Asian equity sales at



"It's going to be painful," says Kim. "But unless they go through with it, Korea is going to be like Japan and not go anywhere."

Fendelander also asks my opinion on WEBS, which were renamed MSCI iShares earlier this year. MSCI iShares are single country closed-end funds which track the

Morgan Stanley Capital International

index for that country and are traded like stocks on the

American Stock Exchange

. They offer some advantages over single country closed or open-end funds. Since they track the country index, the investor can be relatively confident that the iShare will perform as well as the market.

Open- or closed-end funds may underperform the overall market, or they may also overperform, of course. Since iShares are passively managed, they tend to have lower expense ratios. And they can be shorted, unlike closed-end country funds. However, there are around 80 closed-end funds, while only 22 iShares are available now, although six more will be released this year. MSCI iShares offer investors another opportunity for investing overseas, and the more options, the better, I say.

David Kurapka's Global Portfolio column appears Mondays, Wednesdays and Fridays on TSC. In keeping with TSC's editorial policy, he does not own shares in any companies or mutual funds mentioned in this column. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send it to

David Kurapka.