Invest in K-Pop with this new thematic ETF

There are really just two types of ETF investors in 2022's market environment.

The first one is the index ETF investor. Their portfolio is comprised of broad-market, asset allocation ETFs tracking thousands of stocks from every geography, sector, and market cap size. It's intended to be passive and achieve the average return of the world's stock market net of fees. 

The second one is the thematic ETF investor. Their portfolio is a mishmash of various thematic funds. A more typical one might include electric vehicles, solar power, next-generation internet, etc. Or, it could be as weird as meme stocks, breakfast foods, "vice" industries, or inversing Jim Cramer.

And now we can add the Korean pop music industry, or "K-pop," to the list. Are you a die-hard BTS fan (known as a "Stan")? Well, now you can invest in the future of your favorite band via the KPOP and Korean Entertainment ETF (KPOP). Let's take a deep dive into its prospectus.

How the K-Pop ETF works

KPOP passively tracks a proprietary index comprised of 30 companies listed on Korean exchanges that engage in the entertainment and interactive media industry (music, movies, drama, entertainment, and content). Since its debut, the fund has attracted $2.1 million in assets under management (AUM).

KPOP's holdings are selected by an algorithm that scans keywords on company filings and press releases online to assess whether or not they qualify as a "K-Pop company." There is a minimum market cap requirement of $76 million for inclusion. 

Whether or not a company is included in the underlying index depends on its free float-adjusted market cap and K-Pop "relevance score" as assigned by the algorithm:

• For the entertainment industry, the five largest companies by market cap and the top three by K-Pop relevance score will be included. 
• For the interactive media & services industry, the two largest companies by market cap and the top one by K-Pop relevance score will be included. 
• Within the remaining universe of companies, the highest-ranked ones by K-Pop relevance score will be selected until 30 constituents are held. 
• The index will be market-cap weighted, with a target weight of 80% of holdings from the entertainment industry and 20% from interactive media & services, with a 10% cap on any individual holding. 
• The ETF will be rebalanced on a quarterly basis.

My thoughts on the K-Pop ETF

K-Pop has a large and dedicated fan base, but I'm unsure how many of those "Stans" are avid investors eager to invest in a niche thematic ETF. The majority of the population still remains fairly in the dark when it comes to ETF investing, even for popular broad-market, low-cost indexes.

A concentrated thematic fund like KPOP will likely face an uphill battle when it comes to attracting inflows. It faces the challenges of educating a fanbase with little to no investment knowledge and competition against increasingly large numbers of thematic ETFs being launched. 

The main risk here is concentration risk. That is, a sharp downturn in either the K-Pop industry or the Korean economy can cause severe drawdowns for the ETF. Unlike most ETFs investing in the Korean region, this ETF lacks exposure to notable large-cap Korean stocks like Samsung, Hyundai, or LG. 

There's also foreign exchange risk. Holdings in KPOP are denominated in Won, while the ETF itself trades in USD. If the Won depreciates against the U.S. dollar, the net asset value (NAV) of the ETF could lose value even if the underlying holdings increase in value. 

I'm curious as to why KPOP wasn't currency hedged, especially given the recent strength of the USD and the relative power of the U.S. economy compared to the South Korean one. The lack of currency hedging will likely create additional volatility for the ETF. 

That being said, if the USD falls against the Won, the ETF will gain additional value. Maybe reversion to the mean will help KPOP out here. All in all, the best investor profile for KPOP is someone highly knowledgeable about the industry with a bullish long-term thesis.  

Disclaimer: This article is limited to the dissemination of general information pertaining to investment strategies and financial planning and does not constitute an offer to issue or sell, or a solicitation of an offer to subscribe, buy, or acquire an interest in, any securities, financial instruments or other services, nor does it constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment.