[Financial Stability Report] "KOSPI Soared, But Individual Investors Flocked Overseas... Why?"

KOSPI Surges 28.9% in September?October, S&P 500 Up Only 5.9%
Despite the Rally, Retail Investors Net Sell Domestic Stocks, Net Buy Overseas Stocks
Trading Directions of Domestic and Overseas Stocks Diverge, Strengthening the "Substitution Relationship"
Short-Term Returns Exceed Long-Term Expectations, Leading to Domestic Stock Selling and Overseas Stock Buying
Persistent High Exchange Rate Expectations Fuel Hopes for Investment Gains Plus Forex Profits

As the long-term expected returns of the domestic stock market remain relatively low, the recent sharp rise in local stocks has actually strengthened profit-taking among domestic investors, according to recent analysis. The proceeds from profit-taking are being reinvested in the U.S. stock market, fueling the so-called "Seohak Ant" (individual investors investing in overseas stocks) phenomenon. Regarding the recent won-dollar exchange rate, which has been fluctuating above 1,480 won, experts have pointed out that persistent expectations of a high exchange rate have increased hopes for additional foreign exchange gains on investments, further intensifying the Seohak Ant trend. The Bank of Korea stated that if the gap in expected returns between the Korean and U.S. stock markets narrows, the repatriation of individual investment funds to the domestic market could become smoother. However, as these expectations have formed over a long period, it was also noted that policy efforts to improve systems-such as enhancing corporate governance and expanding shareholder returns-must be pursued in parallel.

According to the Financial Stability Report released by the Bank of Korea on the 23rd, even though the KOSPI index surged by 28.9% between September and October this year-far outpacing the U.S. S&P 500’s 5.9% gain-individual investors engaged in net selling of domestic stocks and net buying of overseas stocks. The Bank of Korea explained that there can be either a "complementary relationship," where net investment in both domestic and overseas stocks increases simultaneously, or a "substitution relationship," where an increase in one leads to a decrease in the other. Recently, the substitution relationship has become more pronounced.

Since 2020, the investment patterns of individuals in domestic and overseas stocks have mostly shown a complementary relationship, with net buying in both markets. However, recently, there has been a temporary reversal in the direction of trading between domestic and overseas stocks, strengthening the substitution relationship. During 2020-2021, the net investment by individuals in overseas stocks exceeded ten times that of 2018-2019. At the same time, individuals also made large-scale net purchases of domestic stocks, displaying a pattern of net buying in both markets. In contrast, between February and July 2024, individuals recorded a net sale of 14 trillion won in domestic stocks while making net purchases of 8.3 billion dollars in overseas stocks. The trend continued between July and October this year, with individual investors net selling 23 trillion won in domestic stocks and net buying 10.3 billion dollars in overseas stocks, demonstrating an opposite trading pattern.

On the 23rd, the status board in the dealing room of Hana Bank in Jung-gu, Seoul, displayed the won-dollar exchange rate and the KOSPI index.

In the past, the complementary relationship in individual investors' domestic and overseas stock investments was influenced by factors such as increased domestic liquidity and the effects of portfolio diversification. During periods of expanded domestic liquidity, individual investors increased their net purchases of both domestic and overseas stocks, reinforcing the complementary relationship. Jang Jeongsu, Deputy Governor of the Bank of Korea, stated, "Holding both domestic and overseas stocks simultaneously provides diversification benefits, which also contributed to the formation of a complementary relationship. In particular, the correlation between the returns of U.S. stocks-which account for the majority of Korean individual investors' overseas investments-and domestic stocks (including foreign exchange gains) is lower than that with Japanese or German stocks, so Korean investors can expect relatively greater diversification benefits."

The recent strengthening of the substitution relationship between individual investors' domestic and overseas stock investments has been driven by differences in returns and exchange rate factors. Due to the long-term return gap, investors’ expectations for returns have remained low for the Korean stock market and high for the U.S. stock market. As a result, when the short-term return of the domestic market rises significantly above its long-term expected return, a pattern emerges where investors sell domestic stocks and buy overseas stocks. This incentive became particularly strong during September and October this year, when domestic stock prices rose much more sharply than those in the U.S., making the substitution effect between domestic and overseas stocks especially pronounced. With the recent sharp rise in the exchange rate, expectations for a persistently high exchange rate have continued. The Bank of Korea analyzed that, when purchasing overseas stocks, investors can expect not only stock investment returns but also foreign exchange gains, thereby strengthening the relative attractiveness of overseas stocks.

The Bank of Korea conducted an empirical analysis of the factors influencing individuals’ net investment in domestic and overseas stocks. The results showed that, while the long-term return gap between domestic and overseas stocks has widened, short-term return fluctuations have led to two opposing effects: momentum buying and profit-taking. Both the domestic (KOSPI) and overseas (S&P 500) stock markets showed changes in net investment according to short- and long-term return differences, confirming the impact of return expectations based on long-term returns. However, when short-term returns rise, net investment in overseas stocks tends to increase, while net investment in domestic stocks tends to decrease. This suggests that when both markets rise simultaneously, profit-taking in domestic stocks and momentum buying in overseas stocks may occur.

Deputy Governor Jang stated, "As the gap in expected returns between the Korean and U.S. stock markets has persisted for a long time, and with the recent sharp rise in domestic stock prices, we are seeing trading patterns move in opposite directions between the two markets. This suggests that if the gap in expected returns narrows, the repatriation of individual investment funds to the domestic market could become smoother." He added, "However, since this gap in expected returns has formed over a long period, it is difficult to change investor expectations with only temporary improvements in returns. Policy efforts to improve systems-such as enhancing corporate governance and expanding shareholder returns-are needed to boost the long-term performance and stability of the domestic capital market."