Friday marked the first time a North Korean leader had set foot across the Military Demarcation Line and into South Korea since the Korean War in 1953. The historic meeting between Kim Jong-un and Moon Jae-in culminated in an agreement from both sides to work to de-nuclearise the Korean Peninsula.
But what of the investment case for South Korea? The country’s stock market accounts for 15% of the MSCI Emerging Markets Index and 17.5% of the MSCI Asia Pacific ex Japan Index. Its largest constituent, Samsung Electronics (005930), is the second largest firm in both indices.
The Morningstar Korea Index is one of the best-performing year-to-date, up 2.34%. The KOSPI Index is currently 38% up from its early 2016 low.
The economy continues to improve. It’s now the third-largest in South East Asia and in the three months to September 2017 its economy grew by 1.5%, its best rate of growth since the second quarter of 2010.
“Since the 1960s, very few countries boast as consistent and explosive an economic growth pattern as South Korea,” says Mark Taylor, chief customer officer at Selftrade.
Clearly any thawing of tensions between the two sides would be welcome. But that’s unlikely to alter the investment case for the country, according to fund managers. What is driving increased confidence in South Korea is changes to corporate governance practises.
Korean Stocks Fail to Deliver Dividends
South Korea has long traded on cheap valuation multiples compared to its neighbours, partly as a result of political tensions but more pertinently because of historically poor governance at many chaebols – Korea’s big, family run business empires.
The Korean market has the lowest payout ratio of any major stock market in the world – at around 24% - despite its companies being highly cash rich. “A lack of effective oversight has allowed company managers to simply hold cash back from shareholders,” James Syme, manager of the Morningstar Bronze Rated JOHCM Global Emerging Markets Opportunities Fund, tells us.
But that’s changing. The current Liberal government has introduced a stewardship code, meaning reforms similar to that going on in Japan are improving the environment for shareholders. Chaebols are coming under increasing pressure to up their dividend payout ratios.
Ben Surtees, manager of the Jupiter Asian Fund, says these reforms worked in Japan, boosting valuations on those firms that bought into the code. “Like in Japan, I’m confident the code will also force many Korean companies to relinquish their poor governance practises, which should help improve valuations,” Surtees adds.
Syme says these reforms are needed, as the ageing population in Korea means income is needed more than ever, resulting in the lack of dividends becoming a growing issue in Korean politics.
Surtees, though, doesn’t dismiss the potential benefits reunification could have on the long-term outlook for the economy. Drawing on the example of East and West Germany coming together, he notes that it could be negative in the short term.
However, North Korea has many attractive traits for South Korean firms to draw on, including a large pool of cheap labour that is keen to work. It could also open up trade routes from Seoul to Beijing and through to Moscow and the Middle East.
Surtees concludes: “The short-term consequences would be an extremely bitter pill to swallow for South Koreans and investors alike. But in much the same way that Germany now dominates Europe, Korea could occupy a similar position in Asia in the future.”
Top Rated Funds Invested in South Korea
Syme says South Korea is one of his favourite emerging markets from a top-down perspective. His fund has 21% invested in the region, with his best ideas including Samsung, chipmaker SK Hynix (000660) and carmaker Hyundai Motor Co (005380).
Two Morningstar Silver Rated funds have big weightings to the country, including the Dimensional Emerging Markets Core Equity Fund, which has a bias to smaller cap names. It caps country weightings at 17.5%, and has 17.38% exposure to South Korea.
The Robeco Emerging Stars Equities Fund has almost a quarter of its portfolio invested in Korea. Samsung is its largest position, with chemicals firm Lotte (011170) and bank Shinhan Financial Group (055550) also in its top 10 holdings.
Other Bronze Rated funds with significant exposure to the country include the Invesco Perpetual Asian, Mirae Asset Asia Sector Leader Equity and the passive iShares Pacific ex Japan Equity Index.
