By Ankur Banerjee, Gregor Stuart Hunter and Jihoon Lee
SINGAPORE, July 17 (Reuters) - Billions of dollars in leveraged bets on South Korea's AI darlings have warped a stock market once revered as a reliable barometer of global growth into a wild casino, confounding both regulators and investors.
That volatility, felt on dealing desks from Tokyo to New York, has not only wreaked havoc with portfolios - it has also dramatically distorted investors' views on fundamentals in South Korea, a market at the
heart of the global AI boom.
More than half of all stock market circuit breakers on the benchmark KOSPI - trading curbs activated when the index loses more than 8% for at least a minute - in South Korean history have occurred in the past six months alone.
"The index has decoupled from all of Korea's historical drivers," said Alexander Redman, chief equity strategist at CLSA.
"Korea had been an easy market for strategists, with long-term faithful relationships ... to (help) pick entry and exit points," he said.
Those relationships have since broken down and the main drivers of prices right now are capital flows from an explosion in single-stock leveraged funds, which promise amplified returns but have exacerbated volatility.
The main targets of such funds are chipmakers Samsung Electronics and SK Hynix, big winners in the AI supercycle that now account for more than half of the KOSPI.
The market is wandering from fundamentals. It is neither pricing the full extent of future earnings, with price-to-earnings ratios at Samsung and SK Hynix falling to below 5, nor responding to usually reliable economic correlations.
Volatility for the KOSPI has exploded and prices that once tracked U.S. benchmarks are now instead influencing Wall Street as a rally that doubled the index's market value in six months has turned sharply, losing 20% so far this month.
"In the past, if Korea drops 7% on the day, I would not be talking to you," Redman said. "Now it's normal. But it makes institutional investors increasingly concerned."
DIVORCED FROM FUNDAMENTALS
South Korean retail investors had 34.37 trillion won ($23 billion) in margin loans at stake this week, slightly down from a June record of 38.6 trillion won, in what's become one of the strangest bear markets in recent memory.
The rally rests not just on mountain of borrowed cash but extremely concentrated bets routed through leveraged single-stock exchange traded funds.
Assets in a Hong Kong-listed twice levered SK Hynix fund are up more than 20 times since the start of the year to $7.78 billion, making it the largest of any such fund globally, with rebalancing flows big enough to tilt the market.
"Some of the single-name leveraged ETFs have four times the average volume of the underlying stock," said Florian Neto, head of investment for Asia at Amundi.
"When the assets under management are ballooning, we see the limits of the exercise of giving leverage on single names — this is sending some warning signals for us," he said.
Regulators are trying to walk between damping excesses, without raising worries about a wholesale crackdown that could spook investors and trigger the volatility they are trying to curb.
This week, South Korea sought to block new launches of single-stock leveraged funds.
From August 5, the minimum cash balance required to trade single-stock leveraged ETFs — including those listed abroad — will be tripled to 30 million won ($20,300).
"The volatility in the Korean equity market has been insane recently," said Mike Sell, head of global emerging market equities for London-based asset manager Alquity.
"So measures to restore a focus on fundamentals can only be welcomed...a return to rationality will be positive for long-term investors, in our view."
CAN LEVERAGE WIN?
To be sure, the market's transformation has winners, not least the soaring chipmakers.
Insatiable investor appetite helped SK Hynix to the biggest U.S. capital raise by a foreign company on record last week, raising $26.5 billion.
"Speculative capital is actually making permanent changes to companies," said Michael Green, chief strategist and portfolio manager for Simplify Asset Management.
Still, for investors, who according to Bank of America's fund manager survey think an AI bubble is the top tail risk facing markets, moves in the Korean market matter.
"I actually think it's right for pretty much every investor around the world to be paying very close attention to what's happening in Korea," said Damien Boey, portfolio strategist at Wilson Asset Management in Sydney.
"The bull case is that earnings growth continues, the leverage wins out, and Korean equities fly. I don't think that the market action is telling you that the story is that simple."
($1 = 1,480.3000 won)
(Additional reporting by Hyeyoon Cho in Seoul. Writing by Tom Westbrook. Editing by Sam Holmes)
