The Government s Plan to Revitalize the KOSDAQ Market: Post-announcement Market Conditions and Challenges Ahead

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Mercy Wilkerson
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1 The Government s Plan to Revitalize the KOSDAQ Market: Post-announcement Market Conditions and Challenges Ahead Kang, Sohyun The Korean stock markets no longer move sideways, going through large changes these days. As with the KOSPI market last year, the KOSDAQ market has seen a bull run since late It is premature to say, however, that this rally has resulted from fundamental changes and improvements of the market because it has been buoyed on expectations of the government s plan for invigorating the KOSDAQ market. Above all, the latest market upturn has been driven by strong gains in a few large-cap stocks, more specifically, large-cap pharmaceutical and biotech stocks. Small-cap stocks, which account for a large portion of the KOSDAQ market, posted little gains. Moreover, institutional investors and foreign investors have increased their net purchases of largecap stocks since early On the other hand, they have been net sellers of small-and mid-cap stocks while individuals have remained net buyers. The defection of institutional investors from the small and mid-cap segments makes it more difficult for the KOSDAQ market to achieve long-term stable growth, and reduce its volatility. Finally, recently increased foreign investor participation in the market has declined again in the face of rising US interest rates and stock market s big drop, which confirms that securing and retaining professional investors for the KOSDAQ market is a daunting challenge. It is most necessary to come up with concrete and efficient measures and proactive efforts to improve and foster the market to make sure that the government s ongoing efforts to build a vibrant KOSDAQ market contribute to long-term development and strengthen the intended role of the market. All opinions expressed in this paper represent the author s personal views and thus should not be interpreted as Korea Capital Market Institute s official position. Ph.D., Research Fellow, Capital Markets Department, Tel: , sohyun.kang@kcmi.re.kr 1

2 The Korean stock markets have been undergoing large changes lately. Given the performance of KOSPI and KOSDAQ indices over the past decade, the recent market movements seem drastic. In the 2000 s for the most part, the stock markets showed a prolonged sideways trend. What caused poor stock returns and how to redress them were discussed each year but largely in vain. In fact, the KOSDAQ market moved only slightly even when the KOSPI market started to rise continuously in While KOSPI index rose nearly 22% from January to mid-october 2017, KOSDAQ index increased just 4.9%. The KOSDAQ stock market, however, began its rally at the end of 2017 and went on to make new highs until recently. Even in 2018, a sidecar was triggered twice. 1) On January 12, a jump in KOSDAQ 150 futures and KOSDAQ 150 index continued for one minute, triggering a sidecar which halts program trading for five minutes. On February 8, another sudden big rise in the market activated a second sidecar, temporarily suspending program trading again. It is the change that seemingly enabled the stock market to finish its prolonged sideways drift at once. The recent change in the KOSDAQ market, however, is considered to be short-lived, reflecting expectations of the government s plan to boost the market, rather than the result of fundamental market improvements. Moreover, supplementary measures are urgently needed for long-term development of the KOSDAQ stock market, considering the characteristics of stocks whose prices have increased, and the distribution of stock market investors. Against this backdrop, this article closely investigates changes in the stock markets after the government unveiled its plan to invigorate the KOSDAQ market, and explores challenges ahead for achieving the government s policy goals and ensuring long-term sustainable growth in the KOSDAQ market. 1) A sidecar temporarily suspends program trading in case of sudden big fluctuations in KOSDAQ 150 futures price and KOSDAQ 150 index. This system aims at alleviating shocks to the stock market in the event of a sudden drastic change in the market. 2

3 Figure 1. Stock index movements by market Source: Korea Exchange (KRX) KOSDAQ market changes before and after the government s announcements From late 2017 ouwards, the government has continued to announce its policy measures to foster the KOSDAQ market. The market has reacted immediately every time market revitalization measures were unveiled. On November 2, 2017, the government disclosed its plan to create an ecosystem for innovative startups, and also said that it would come up with measures to facilitate financial innovation centering on the KOSDAQ market in December. Then, it unveiled key elements of measures in advance, e.g., strengthening the independence of the KOSDAQ market by setting up a KOSDAQ committee; introducing a scheme to encourage institutional investors such as pension funds to invest more in the KOSDAQ market. On December 7, 2017, however, the government delayed its scheduled policy announcement. In its 2018 Economic Policies released on December 27, the government reaffirmed its strong will to support the establishment of a startup ecosystem by revitalizing the KOSDAQ market. Eventually, on January 11, 2018, it announced its measures to vitalize the KOSDAQ Market. The measures include strengthening market independence, inducing major pension funds to increase their investments in the KOSDAQ market, facilitating KOSDAQ venture funds and providing financial support, and lowering market entry barriers. 3

4 Figure 2. KOSDAQ index movements before and after the government s announcements Source: KRX As shown in the figure above, the upward trend strengthened further or the downward trend turned back up, supported by market expectations following the government s KOSDAQ-related policy announcement. Even the KOSDAQ market jumped sharply, triggering a sidecar, when the government made its policy announcement on January 11, 2018, although most key elements of the measures were already revealed last December. It is difficult to rule out the government s policies when discussing the recently vibrant KOSDAQ market. This implies that market participants have high expectations on the government s policies towards the KOSDAQ market. The sharp rise in the KOSDAQ reflects drastically increased expectations of government support for the stock market. However, longterm market development should be underpinned by an increase in the value of companies listed on that stock market, regardless of temporary assistance such as government support. It means that the market will not be able to continue its upward trend or turn downward when the government s measures fall short of investor expectations. A bull run led by large caps and one specific sector I looked at the characteristics of stocks that drove the market rally in order to understand changes in the KOSDAQ market before and after the government s announcements to vitalize the market. The stock price movements suggest that the recent upturn was pronounced in a small number of large-cap stocks rather than small-cap stocks that represent the majority of the KOSDAQ market, indicating the stock market rally driven mostly by large-cap stocks. Top 100 4

5 KOSDAQ companies enjoyed a 60%p rise in their market capitalization or market cap whereas small-cap companies showed little change despite the stock market boom. Figure 3. Stock price movements in the KOSDAQ market for different categories of stocks based on size Note: The stock price level of each category on January 2, 2017 is converted into 100, assuming that each category s price level starts from 100. Large caps are defined as top 100 stocks in terms of average daily market capitalization, mid caps as the 101 st stock to 400 th stock, and small caps as any stock beyond the 401 st stock. Source: KRX Especially, the KOSDAQ exhibits a high concentration in a few large-cap stocks. The combined market capitalization of top 10 companies reached 17.4% of the total market capitalization of the stocks listed on the KOSDAQ as of February 20, Even there were big gaps between the largest company and the rest of the top 10 companies. The largest company on the KOSDAQ was Celltrion Healthcare, with a market cap of KRW 17.3 trillion. The market cap of ShillaJen, the second largest firm, amounted to KRW 6.2 trillion, one third of Celltrion Healthcare s market cap. The market cap of Medytox, the third largest, was merely KRW 3.6 trillion, one fifth of the largest firm s. Furthermore, as market participants already know, most of largest companies by market value are pharmaceutical and biotech companies such as Celltrion Healthcare. The top 10 list is dominated by six companies in the pharmaceutical and biotech sector. 5

6 Figure 4. KOSDAQ market by sector market cap Note: The market cap level of each sector on January 2, 2017 is converted into 100, assuming that each sector s market cap starts from 100. Source: FnGuide; KCMI computation What is worrisome is that the current bull market led by a handful of companies and one particular sector may quickly turn bearish when some top-ranked companies leave the KOSDAQ and list their stocks on the KOSPI, or when pharmaceutical and biotech sector slows down. For example, the market value of pharmaceutical and biotech firms in the KOSDAQ market plummeted when Celltrion moved to the KOSPI market on February 9, Higher individual investor concentration in small-cap stocks When it comes to investor composition, individual investors appear to have been more drawn to small-cap stocks. I looked into net purchases of KOSPI and KOSDAQ stocks among different types of investors to investigate shifts in the trading behavior of stock market investors. Figure 5, 6, and 7 depict the net purchases of top 300 large-cap stocks, mid-cap stocks (the 301 st to 1,000 th ), and small-cap stocks among different types of investors, and the average foreign ownership of large-cap, mid-cap and small-cap companies. The figures below reveal clear differences between large-cap stocks and small-and mid-cap stocks. Figure 5 suggests that the cumulative net purchases of large-cap stocks by foreigners increased steadily from January to July 2017, and have remained at certain levels since then. Domestic institutional investors turned net buyers later than foreign investors, but this trend has continued since mid-july 2017, resulting in sizable cumulative volume of institutional net buying as of February By contrast, individual 6

7 investors have remained net sellers, signaling their exodus from the large-cap segment. As for mid-cap stocks, the net buying trend changed before and after November Before November 2017, the net purchases of mid-cap stocks by individual investors continued to grow whereas the net sales by institutional investors increased. This trend was reversed in November Individual investors sold mid-cap stocks, but institutional investors bought them. In the meantime, individual investors have remained net buyers in small-cap stocks until recently whereas institutional investors have increased their net sales. Figure 5. Cumulative net purchases of Korean large-cap stocks by investor type Source: FnGuide Figure 6. Cumulative net purchases of Korean mid-cap stocks by investor type Source: FnGuide 7

8 Figure 7. Cumulative net purchases of Korean small-cap stocks by investor type Source: FnGuide Taken all together, the large-cap segment becomes increasingly dominated by professional investors, evidenced by the increased foreign and institutional ownership of largest marketcap companies in the stock markets. On the contrary, the small-and mid-cap segments show a higher degree of retail concentration, which resulted from the increased net buying of small-and mid-cap stocks by individuals. Due to the nature of KOSDAQ-listed firms, small-cap stocks take up the majority of the KOSDAQ market, compared to the KOSPI market. Approximately 1,988 companies listed on the KOSPI and KOSDAQ markets from 2017 to February 20, 2018 can be divided into three groups based on market value: the top 300 large-cap group, mid-cap group (the 301 st to 1,000 th ), and small-cap group. KOSPI companies are distributed evenly across the three groups, with 238 in the top 300 large-cap group, 297 in the mid-cap group, and 215 in the small-cap group. In the KOSDAQ market, on the other hand, 62 firms are in the top 300, 403 in the mid-cap group, and 773 in the small-cap group. Given that only a small portion of KOSDAQ-listed firms fall into the top 300 group, the increased institutional investment in large-cap stocks is highly likely to be limited to a handful of KOSDAQ-listed firms. If this trend continues, the defection of institutional investors from the small-cap segment, and the increased influx of retail investors into the same segment would have larger impact on the KOSDAQ than on the KOSPI because the majority of small-cap stocks are KOSDAQ listed. 8

9 Increased foreign investment in the KOSDAQ market, and heightened market volatility caused by external factors The KOSDAQ market boom has come along with a rise in foreign investor participation. The share of foreign ownership rose from about 10% in early 2017 to 14% at the end of January This is a marked increase when compared to the KOSPI market where the share of foreign ownership edged up from 35% to 37% over the same period. Figure 8. Changes in the share of foreign ownership by market However, the increase in the foreign ownership of KOSDAQ stocks entailed a rise in market volatility. The percentage of stocks owned by foreigners, in particular, appears to have been affected further by changes in the US stock markets. Recently, the stock market indices pulled back sharply and foreign investors fled from the domestic stock markets as rising interest rates and tumbling stock markets in the US caused a downturn in investor sentiment. Consequently, the proportion of foreign ownership in the KOSDAQ market plunged from 14% on January 18 to 11% on February 20, Meanwhile, the proportion of foreign investors in the KOSPI market changed only slightly, hovering around 37% during the same period. This suggests that the rapidly changed KOSDAQ market is more susceptible to external influences, and the influx of foreign investors turned out to be fleeting, not lasting. Challenges ahead for developing the KOSDAQ market The recent boom in the KOSDAQ is a positive phenomenon, allowing for the previous stagnation. As discussed earlier, however, it may be difficult to see the present situation - i.e., 9

10 the market rally led by a small number of companies, the polarization of investors between large caps and small/mid caps, and the greater market volatility affected by external factors- as a shift towards stable growth. Concrete policy measures are crucial for the policy-driven KOSDAQ market rally to be sustainable, not short-lived. First, it is necessary to analyze the KOSDAQ market s characteristics and redefine its identity, among other things. While mid-and large-cap companies are not densely distributed in the KOSDAQ market, small-cap companies comprise the very large proportion of KOSDAQ-traded companies. In addition, the KOSDAQ market is in fact more complex than the KOSPI market because it has a wider range of companies. Judging from the government s plan for revitalizing the KOSDAQ market, it is envisaged that the KOSDAQ market will grow enough to compete on an equal footing against the KOSPI market. But the existing distributions of listed companies in the two stock markets by market cap indicate that the KOSDAQ can hardly compete directly with the KOSPI due to the high concentration of small-cap companies. It is highly likely that large-cap companies and some mid-cap companies in the KOSDAQ market can compete with their counterparts in the KOSPI market. As yet, it is hard to say that the KOSDAQ market is competitively superior to the KOSPI market. For instance, flagship KOSDAQ companies, such as Naver, Kakao, and Celltrion moved their stock listings to the KOSPI over the past few years. The transfer of these listings stirred up conflicts between the two stock exchanges. When the recent stock market conditions are taken into account, conflicts between the exchanges will likely be stirred up again when large-cap companies listed on the KOSDAQ move to the KOSPI. Unless the transfer of listing is recognized as an achievement of the KOSDAQ market, its effect on the KOSDAQ would become far bigger. To prevent unfruitful competition between the two major exchanges which consist of the Korean stock market, fundamental analysis is needed to find out what causes differences between firms listed on the KOSPI and mid-and large-cap firms listed on the KOSDAQ, and differences in investor preferences for the two markets. Further, constant efforts, built on the analysis findings, should be made to enhance the KOSDAQ market s competitiveness. Second, competitive relationship should be defined and established not only between the large-cap segments of the two markets but also between the small-cap segments. The measures to invigorate the KOSDAQ market are intended to attract companies with strong growth potential to list their stocks on the KOSDAQ, regardless of their size and performance by greatly 10

11 relaxing its listing requirements. The overhaul of the listing requirements would help more startups without any tangible financial results to enter the KOSDAQ market. However, this is also what the KONEX market aims for. The KONEX market is a new market established to support the growth of early-stage venture SMEs. Early-stage startups are permitted to list their stocks on the KONEX if they demonstrate their future growth prospects in a qualitative evaluation. The KONEX market, which was launched to reduce structural voids between the KOSDAQ market and the over-the-counter-market for venture SMEs, may lose their distinctive position in the capital markets if the KOSDAQ significantly eases its quantitative listing requirements and expands its growth potential assessment. Thus, it is required to redefine the roles and relationship between the KONEX and KOSDAQ markets. Third, trust and investor protection issues will likely arise from the eased KOSDAQ listing requirements. The KONEX market has the designated advisor system in place to evaluate and assist companies to be listed on the market in order to address ambiguity in standards for assessing a startup s potential growth, and also limits participation to accredited investors. The relaxed KOSDAQ listing requirements in effect makes the stock exchange play the role of a designated advisor and be held more accountable if any investor protection problem occurs. This calls for more elaborated measures to strengthen investor confidence and protect investors in the KOSDAQ market. Lastly, it is also crucial to come up with concrete measures to nurture the growth of smalland mid-cap KOSDAQ companies. The government plans to provide tax breaks for individuals investing in KOSDAQ venture funds, and to create a KOSDAQ Scale-Up Fund with relevant securities industry organizations. It seems necessary to take a prudent and cautious approach to supporting the market where a significant portion of small- and mid-cap stocks are held by individual investors. For large-cap stocks with relatively high institutional ownership, corporate analysis is undertaken mainly by institutional investors. On the other hand, such analysis is not sufficient for small-and mid-cap stocks. To ensure that government support through the scaleup fund produces satisfactory results, it is required to sort out companies with strong potential for growth among listed companies, and assess their growth potential. Fostering the KOSDAQ market requires meticulous attention and approaches, given a lack of reference data available for analysis, and possible consequences from wrong choices, for example, intense influx of individual investors, and further market confusions. 11

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