South Korea is the canary in the coalmine of the AI boom
South Korea’s experiment with leveraged single-stock ETFs has shown how quickly passive investing, concentrated markets and retail speculation can feed on one another, says Helen Thomas
The new frontier for the AI boom isn’t Silicon Valley but South Korea. While the country has long been home to technology giants such as Samsung Electronics, the country’s stock market has taken on an entirely different character this year. The benchmark KOSPI has delivered extraordinary gains, having doubled since the start of the year, driven overwhelmingly by a handful of semiconductor stocks at the heart of the artificial intelligence supply chain.
The standout performer has been SK Hynix, now the world’s second-largest memory chip manufacturer and the leading producer of high-bandwidth memory (HBM) chips. These chips have become indispensable for training and running large AI models, making them a critical component in Nvidia’s AI ecosystem. Together with Samsung Electronics, SK Hynix has become the engine of South Korea’s stock market, with the two companies now accounting for around half of the KOSPI’s market capitalisation.
But every speculative boom brings its own risks.
As money has flooded into Korean technology stocks, volatility has surged. The KOSPI has experienced swings on a scale rarely seen in recent years, including days when circuit breakers were triggered after falls approaching 10 per cent. The South Korean won has also weakened sharply against the US dollar, at one stage falling to its weakest level since the global financial crisis, highlighting growing concerns over capital flows and financial stability.
The government had hoped to encourage domestic investment and stem the tide of Korean savings flowing into US equities. In May, regulators approved the country’s first leveraged single-stock exchange traded funds, allowing investors to take twice the daily exposure to companies such as Samsung Electronics and SK Hynix.
The policy was intended to deepen domestic capital markets. Instead, it may have intensified the very volatility policymakers were trying to avoid.
Leveraged ETFs
Leveraged ETFs promise a multiple of a stock’s daily return, forcing fund managers to rebalance their positions every day. If investors poured money into a 2x SK Hynix ETF after the stock had already risen, the fund would need to buy even more SK Hynix shares or increase its derivative exposure in order to maintain its leverage. If investors rushed for the exits, the reverse would happen, forcing additional selling into falling markets. In other words, the flows themselves become pro-cyclical, mechanically amplifying price movements in both directions.
Within weeks, South Korea’s own regulator was questioning whether the products had been introduced too quickly. Lee Chan-jin, governor of the Financial Supervisory Service, delivered one of the more remarkable admissions ever heard from a financial watchdog: “Maybe I should have lain down on the floor to block it. I personally regret I didn’t.”
The problem is compounded by leverage elsewhere in the system.
Retail investors have increasingly borrowed to participate in the rally. A recent Bank of Korea report showed leveraged investment into equities by retail investors reached a record 60 trillion won (around $39bn) by the end of May, as the KOSPI became one of the world’s strongest-performing equity markets. The central bank explicitly identified FOMO (fear of missing out) as a major driver of speculative activity, while the country’s finance minister has warned that authorities are monitoring “excessive herd-like behaviour”. Daily trading volumes on the KOSPI are now around four times higher than a year ago.
The consequences extend well beyond soaring share prices. They are changing the very structure of the Korean equity market itself.
Passive and leveraged ETF inflows increasingly concentrate ownership of a very small number of stocks. Goldman Sachs, drawing on EPFR data, estimates that leveraged ETF exposure as a percentage of the free-float capitalisation of the underlying shares has risen from roughly 0.8 per cent at the start of the year to almost three per cent.
That may sound modest, but in an already concentrated market it matters. As more shares become effectively locked inside passive investment vehicles, the pool of stock available for active trading shrinks. The marginal buyer or seller therefore has a greater impact on prices, making the underlying shares less liquid at the margin and potentially more volatile.
The evidence suggests the market has already entered a different volatility regime. Last year, the KOSPI’s average daily move was around one per cent. This year, almost one fifth of trading days on the MSCI Korea index have seen moves of five per cent or more.
It would be wrong to blame leveraged ETFs alone. The AI boom, foreign capital inflows, retail speculation and the extraordinary concentration of the Korean equity market have all contributed. The ETFs are better understood as an amplifier than the original cause.
Financial markets often reveal the stresses created by new investment fashions before they appear elsewhere. South Korea’s experiment with leveraged single-stock ETFs has shown how quickly passive investing, concentrated markets and retail speculation can feed on one another. If the AI frenzy eventually runs out of steam, South Korea may prove to have been not just the hottest AI market in the world, but the canary in the coalmine for wider financial market risk.
Helen Thomas is founder and CEO of Blonde Money