🚨 Korean Retail Investors Should Heed Bank of Korea's Diversification Advice
Today Korean Economic News | 2025.03.27
📌 Korean Retail Investors Should Heed Bank of Korea's Diversification Advice
💬 The Bank of Korea has advised individual investors focusing on overseas stocks to avoid concentration in specific stocks and to diversify their risk by investing in various domestic and international stocks. In particular, it pointed out excessive investment in M7 (Apple, Microsoft, Nvidia, Amazon, Google, Meta, Tesla) and leveraged ETFs, emphasizing the need for portfolio diversification to prepare for volatility.
1️⃣ Easy Understanding
The Bank of Korea has recommended diversification to overseas stock investors known as 'Seohaggaemi'. I'll explain the background and meaning of this recommendation in simple terms.
'Seohaggaemi' refers to Korean individual investors who invest in stocks from western countries like the United States. In recent years, overseas stock investments by domestic investors have increased significantly, with a particular focus on large tech stocks in the US market, known as M7 (Apple, Microsoft, Nvidia, Amazon, Google, Meta, Tesla).
The Bank of Korea is concerned about this investment concentration. When too much money flows into specific stocks or sectors, investors can suffer significant losses if market conditions suddenly change. For example, many investors who primarily invested in M7 experienced substantial losses when tech stock prices fell sharply in early 2022.
High-risk products like leveraged ETFs are also a concern. Leveraged ETFs are products that seek returns (or losses) 2-3 times greater than the price changes of the underlying asset. While they can yield high returns in the short term, they also carry greater risk of loss when markets are unstable.
Diversification means "don't put all your eggs in one basket," a fundamental investment principle. It's a strategy to reduce the impact of a downturn in a specific area on your overall portfolio by dividing investments across multiple stocks, industries, and countries. For example, investing not only in tech stocks but also in finance, healthcare, energy, and other industries, or investing in stocks from regions beyond the US, such as Europe and Asia.
The importance of diversification is especially highlighted now, given potential market volatility due to uncertainties in US Federal Reserve interest rate policies, political uncertainties ahead of the presidential election, and valuation concerns for tech stocks.
The Bank of Korea's recommendation can be seen as advice for individual investors to manage risk through diversification from a long-term perspective rather than focusing on short-term gains. While investment always carries risk, you can achieve better investment results in the long run by properly managing that risk through diversification.
2️⃣ Economic Terms
📕 Seohaggaemi
Seohaggaemi refers to Korean individual investors who invest in Western stock markets, particularly the US.
- 'Seo' means west (US), and 'gaemi' means ant (individual investor), contrasting with 'Donghaggaemi' who invest in domestic stocks.
- The number of individual investors expanding their overseas investments has increased significantly since 2020 due to the low-interest environment and limitations of the domestic market.
📕 M7 (Magnificent Seven)
M7 refers to seven large tech companies (Apple, Microsoft, Nvidia, Amazon, Google, Meta, Tesla) that are leading the US market.
- These companies lead in advanced technology fields such as artificial intelligence and cloud computing, accounting for a significant portion of the S&P500 index's rise.
- While they attract attention for their high growth potential, valuation concerns and regulatory risks have been increasing recently.
📕 Leveraged ETF
A leveraged ETF is an exchange-traded fund that seeks returns at multiples (2x, 3x, etc.) of the price movement of the underlying asset.
- It is designed to generate returns (or losses) at multiples of index movements using derivative products.
- While it is an investment tool for betting on short-term market direction, long-term holding can result in divergence from expected returns due to volatility decay effects.
📕 Diversification
Diversification is an investment strategy that reduces risk by dividing investments across various asset classes, regions, industries, and stocks.
- By investing in assets with low correlation, the overall volatility of the portfolio can be reduced.
- While it cannot eliminate systematic risk (overall market risk), it has the effect of reducing non-systematic risk (individual stock risk).
3️⃣ Principles and Economic Outlook
💡 Korean Retail Investors' Investment Concentration Phenomenon and Its Background
Let's examine the background and current status of Korean individual investors' concentration in overseas stocks, particularly US large-cap tech stocks.
First, the scale and concentration of Seohaggaemi's overseas investments have increased dramatically in recent years. According to Bank of Korea data, Korean individual investors' overseas stock investment balances have more than tripled from about $30 billion at the end of 2020 to about $100 billion in early 2024. Notably, about 80% of this is concentrated in the US market, and among US investments, about 60% is in M7 companies. This is twice the proportion of M7 in the S&P500 index (about 30%). Investment in high-risk products such as leveraged ETFs has also increased, accounting for about 20% of total ETF investments. This concentration shows that Korean individual investors' portfolios are excessively exposed to specific companies and sectors.
Second, there are various structural and psychological factors behind the Seohaggaemi phenomenon. The limitations of the domestic investment environment are one of the main reasons for the increase in overseas investments. The Korean stock market accounts for only about 2% of the global market, and its industrial composition is concentrated in specific fields such as semiconductors, automobiles, and shipbuilding. This makes access to overseas markets essential for investing in innovative industries that are global trends, such as AI, cloud, and electric vehicles. Additionally, the chronic 'Korea discount' in the Korean market and low dividend yields also drive investors overseas. The development of digital platforms, which has greatly improved accessibility to overseas investments, is also an important background. Overseas investments that were previously limited by complicated procedures and high fees are now easily accessible through mobile apps.
Third, clear performance and psychological factors influenced the concentration in M7 companies. M7 companies have achieved continuous growth through innovative products and services over the past decade, with significant stock price increases. In particular, the acceleration of digital transformation after the pandemic and the AI boom further promoted the growth and stock price rise of these companies. The fact that about 60% of the S&P500 index's rise in 2023 was contributed by M7 served as a strong investment rationale for investors. Along with the intuitive investment logic of 'invest in successful companies,' FOMO (Fear Of Missing Out) psychology also encouraged concentrated investment. Information sharing and herd behavior through social media and investment communities also reinforced the concentration phenomenon in specific stocks.
Fourth, there are unique factors in the increase of high-risk product investments such as leveraged ETFs. The 'yield hunger' phenomenon of seeking high returns in a low-interest environment has led investors to take on higher risks. The high returns that leveraged ETF investors earned during the rapid market rebound after the pandemic in 2020-2021 further amplified interest in these products. Many novice investors also tend to invest expecting high returns without fully understanding the risks and operating mechanisms (daily rebalancing, volatility decay effects, etc.) of leveraged ETFs. In particular, interest in leveraged products has increased as aggressive investment strategies focused on short-term returns are shared in some online investment communities.
This investment concentration phenomenon among Seohaggaemi can bring substantial returns in the short term but can significantly increase portfolio risk in the long term. Particularly when market environments change or specific sectors undergo corrections, excessively concentrated investments can lead to significant losses. Therefore, the Bank of Korea's diversification recommendation can be seen as an important warning for the long-term asset stability of individual investors.
💡 The Risks of Concentrated Investment and the Importance of Diversification
Let's examine what risks are inherent in concentrated investments in specific stocks or sectors, and why diversification is important.
First, concentrated investment has the problem of excessive exposure to non-systematic risk (individual stock risk). Investment risk can be broadly divided into systematic risk, which affects the entire market, and non-systematic risk, which affects only specific companies or industries. When investing in specific companies like M7, you are greatly affected by individual issues with those companies (poor performance, management changes, regulatory risks, etc.). For example, when Meta (formerly Facebook) saw a sharp decline in stock price in 2022 due to expanded metaverse investments and decreased advertising revenue, portfolios concentrated in Meta took a severe hit. In contrast, if investments had been diversified across various stocks, the impact of such individual stock declines on the overall portfolio would have been limited.
Second, specific sector concentration is vulnerable to industry cycles and regulatory changes. M7 are all companies belonging to the tech sector, influenced by similar industry cycles and regulatory environments. In particular, recent moves to strengthen regulations on AI and big tech are risk factors that could simultaneously affect all these companies. When tech stocks overall underwent corrections in early 2022 due to inflation concerns and rising interest rates, portfolios concentrated in the tech sector experienced significant losses. In contrast, if investments had been diversified across various sectors such as energy, finance, and healthcare, the tech sector decline could have been partially offset by the performance of other sectors. By investing in industries with different economic cycles, the overall portfolio volatility can be reduced.
Third, geographic concentration is vulnerable to country-specific economic conditions and currency value fluctuations. Excessive concentration in the US market makes investors highly susceptible to US economic conditions, monetary policy, and political uncertainties. Additionally, KRW-USD exchange rate fluctuations significantly impact investment returns. For example, if the dollar strengthens due to US interest rate hikes, returns in KRW terms can improve due to foreign exchange gains, but the opposite can result in foreign exchange losses. Geographically diversified investments can disperse risks associated with differences in country-specific economic cycles and currency value fluctuations. By investing in various regions such as Europe, Asia, and emerging markets, the impact of economic shocks in specific regions on the overall portfolio can be limited.
Fourth, attention should also be paid to the structural risks of leveraged products. Leveraged ETFs are designed based on daily returns, which can lead to results different from expectations when held long-term. Especially in volatile markets, they can record lower returns than the underlying asset due to the 'volatility decay' effect. For example, if a 100 won asset rises 10% in one day and then falls 10% the next day, it becomes 99 won, but a 2x leveraged product rises 20% and then falls 20%, becoming 96 won. Thus, in markets with repeated ups and downs, leveraged products can diverge from expected returns in the long term. Therefore, leveraged products should be used limitedly as a strategic tool for betting on short-term market direction, and more stable products should be used as core assets for the portfolio.
The essence of diversification is 'not putting all your eggs in one basket.' According to modern portfolio theory, by diversifying investments across various assets with low correlation, you can reduce the risk of the entire portfolio while maintaining expected returns. Of course, diversification cannot eliminate all risks, and systematic risks such as overall market declines still exist. However, it can significantly reduce non-systematic risks related to individual stocks, sectors, and regions, which plays an important role in enhancing the stability of long-term investment performance.
💡 Effective Diversification Strategies and Implementation Plans
Let's look at effective diversification strategies for Seohaggaemi to implement the Bank of Korea's recommendation.
First, a systematic approach through asset allocation is needed. The first step in effective diversification is determining the appropriate allocation among major asset classes such as stocks, bonds, cash, and alternative investments. This can vary depending on the investor's age, investment goals, and risk tolerance. For example, younger investors can allocate a higher proportion to stocks, while investors close to retirement should increase the proportion of stable assets like bonds. Since each asset class responds differently in different economic environments, appropriate asset allocation is important for reducing overall portfolio risk. Especially for portfolios consisting only of stocks, which can experience high volatility during market downturns, it's worth considering combinations with other assets such as bonds, gold, and REITs (Real Estate Investment Trusts).
Second, geographic diversification is needed to disperse country-specific risks. Given that Seohaggaemi's overseas investments are currently excessively concentrated in the US market, geographic diversification is an important task. By investing in various regions such as Europe, Japan, and emerging markets, the impact of economic recessions or political instabilities in specific countries on the overall portfolio can be reduced. Each region has different economic cycles, industrial structures, and monetary policies, providing high diversification effects. For example, the US tech-centered growth market and Europe's value stock-weighted market can show different patterns. Using global ETFs or region-specific ETFs is an efficient method for individual investors to achieve regional diversification.
Third, industry diversification is needed to manage sector-specific risks. Investments concentrated in M7 have the problem of excessive exposure to the tech sector. By investing in various industries such as healthcare, finance, energy, consumer goods, and utilities, industry-specific cycles and regulatory risks can be dispersed. Each industry responds differently to economic fluctuations, inflation, and interest rate changes, so diversifying across various industries increases portfolio stability. For example, during periods of rising interest rates, tech stocks may underperform while financial stocks may show good performance. Using industry ETFs or sector ETFs allows efficient investment in specific industries.
Fourth, diversification of investment styles is also an important strategy. Investments can be broadly categorized into various styles such as growth stock investment, value stock investment, large-cap and small/mid-cap stocks, and dividend stocks. Since M7 are mostly large-cap growth stocks, investments concentrated in them are also biased in investment style. Historically, growth stocks and value stocks have shown a cyclical pattern where they outperform in different periods. For example, growth stocks were dominant in the late 2010s, but value stocks tend to perform better during inflation and rising interest rate phases. Therefore, by diversifying across various investment styles, risks associated with changing market environments can be reduced.
Fifth, using index investments and indirect investments is also an effective method. It requires time and expertise for individual investors to directly select and manage various stocks. By investing in products that track broad market indices such as S&P500 index ETFs or MSCI World index ETFs, diversification effects can be naturally achieved. For example, an S&P500 ETF provides the effect of diversified investment across 500 representative US companies, allowing pursuit of market returns with much lower risk than concentrated investment in M7. Additionally, mutual funds or active ETFs managed by professional management companies can also be considered as professional diversification tools.
Effective diversification is not simply investing in many stocks, but systematically allocating across various assets, regions, industries, and styles with low correlation. It's important to establish an asset allocation strategy that fits the investor's personal situation and goals, and to maintain the discipline of regularly rebalancing the portfolio. Additionally, it's essential to understand that while diversification does not guarantee maximum short-term returns, it significantly contributes to improving risk-adjusted returns in the long term and enhancing the sustainability of investments.
4️⃣ In Conclusion
The Bank of Korea's diversification recommendation for Seohaggaemi stems from concerns about excessive concentration in M7 companies and leveraged ETFs in recent overseas stock investments. Investments concentrated in specific stocks or sectors can bring high returns in the short term but carry the risk of significant losses when market environments change.
The dangers of such concentrated investments have been historically confirmed multiple times. In cases such as the dot-com bubble burst in the early 2000s, the 2008 financial crisis, and the 2022 tech stock plunge, portfolios concentrated in specific sectors or stocks experienced serious losses. In contrast, portfolios diversified across various assets and sectors could maintain relatively stable performance.
Diversification is the basic investment principle of 'not putting all your eggs in one basket.' By appropriately diversifying across different asset classes (stocks, bonds, cash, alternative investments), various regions (US, Europe, Asia, emerging markets), multiple industries (technology, finance, healthcare, energy, etc.), and diverse investment styles (growth stocks, value stocks, dividend stocks), the overall risk of the portfolio can be effectively managed.
The importance of diversification becomes even greater in environments like the current one, with various risk factors such as interest rate policy uncertainties, inflation concerns, geopolitical risks, and valuation concerns for tech stocks. There is no guarantee that the excellent performance of M7 companies will continue indefinitely, and other sectors or regions may show better performance depending on changing market environments.
Seohaggaemi can easily achieve diversification effects by using S&P500 index ETFs, global index ETFs, etc. They can also construct portfolios that match their investment tendencies and market outlook by combining sector ETFs, regional ETFs, etc. High-risk products like leveraged ETFs should be used limitedly as a part of the portfolio and are more suitable as short-term strategic tools rather than for long-term holding.
In conclusion, the Bank of Korea's diversification recommendation is important advice for Seohaggaemi's long-term investment success. Rather than chasing high returns by concentrating investments in certain popular stocks, the approach of a wise investor is to manage risk and pursue sustainable returns through systematic asset allocation and diversification strategies. While it's difficult to predict short-term market flows, it's important to remember that risk management through diversification is one of the most effective strategies that investors can directly control.