A US-North Korean war would have a big impact on institutional emerging-market equity portfolios, given South Korea's chunky weighting in EM benchmarks.

Asset owners globally had $220 billion of exposure to South Korean stocks via active fund managers as of the second quarter of this year, according to data provider eVestment. Those in Chinese, Indian and Taiwan – and of course South Korea – own the biggest allocations. (Globally fund houses report $36 trillion worth of actively managed institutional allocations to eVestment.)

Institutional investors appear to have been underweight South Korean equities since at least the first quarter of last year, Peter Laurelli, head of research at eVestment, told AsianInvestor.

But their allocation to the country is still substantial: it averaged, via active funds, 11.0% in the second quarter, versus the country's weighting in the widely used MSCI EM benchmark of 15.61%, according to eVestment.

Asset owners likely also have a large and growing allocation to South Korean stocks via passive investments such as exchange-traded funds, Laurelli said.

There were outflows from EM stocks in 2016 after the MSCI's EM index fell -15.81% between September 2014 and end-2015 (while global stocks gained 1.39%), he noted.

“But money has now started to return, primarily into passive EM strategies,” said Laurelli. “Since such investments tend to hug more closely to the global benchmark, they will provide higher exposure to South Korea.”

In fact, while net flows into South Korea equity ETFs have slowed in the past two weeks, they have remained positive, according to research house ETFGI (see table below).

Net new flows into South Korea equity ETFs ($m)

Type NNA week ended 21 July NNA w/e 28 July NNA w/e 4 August  NNA w/e 11 August
Leveraged -89.53 165.76 349.06 195.38
Leveraged Inverse 0.23 -12.42  -61.08  -27.63
Normal 246.50  515.31  105.39  27.61
Total 157.20  668.65  393.37  195.36

Source: ETFGI

It seems investors have remained relatively relaxed about the situation, in spite of the escalating level of threats issued by US president Donald Trump and North Korea's Kim Jong-un.

While the risk of a military conflict shook financial markets’ confidence last week, some of the fear has dissipated thanks to reports yesterday that North Korea has decided to pull back from an attack on Guam.

Indeed, French bank Natixis argued in a note yesterday that South Korea was unlikely to be materially impacted by the heightened North Korea-related tensions. It argued that the situation was “an escalation but not a change in the status quo”.

As a result, investors – both domestic and foreign – will continue to rule out a worst-case scenario, namely that of a military conflict, said the note.

Natixis also pointed to a number of factors likely to support continued investment into South Korea: the fact that it is undergoing a cyclical upturn; foreign capital has continued to flow in, despite the heightened risk; the country does not depend on external funding for its investment due to sizeable current account surpluses (7% of GDP in 2016); and the government has passed a fiscal stimulus package to boost growth.

Why, then, have investors been underweight South Korean equities since at least early 2016? A likely driver of this is that the big Korean companies, such as Samsung, are big suppliers to developed markets, noted Laurelli. “So for emerging-market managers looking for good-value opportunities in under-serviced areas, South Korea is not necessarily high on their list.”