Korea: Seoul-searching investments

Korea has dominated headlines for a few reasons recently, from heightened tensions between North Korea and the US, to South Korea’s hosting of the 2018 Winter Olympics in February.

As our first foray into exploring single-country markets, we shine the spotlight on the South Korea’s economic backdrop, market movements, and whether Elite Rated managers are finding opportunities in the market area.

Backdrop

South Korea is Asia’s fourth-largest economy, and is the 11th largest economy in the world. It is largely export-led and depends heavily on shipping steel, ships and cars – and has done since the 1950s, when the country experienced rapid growth in the immediate aftermath of the Korean war – the ‘Miracle of the Hangang River’. For example, South Korea is home to car manufacturers Hyundai, Daewoo, and Kia.

The country has also always been a big player in the technology sector, with Samsung Electronics having been around for many years. But importantly, the company – as well as the country’s tech sector as a whole – has remained on top of the game relative to its peers. Aside from Samsung, for instance, the South Korean stock market – the KOSPI’s – largest individual weightings also include the likes of LG Electronics, wireless telecoms operator SK Telecom and memory chip supplier SK Hynix.

In terms of market behaviour, the KOSPI underperformed the global MSCI All Country World index over three, five and 10 years*. But then again, most emerging markets (with the exception of China) have done, as they have struggled to recover from the 2008 financial crisis.

However, the Korean equity market has outperformed most major developed and developing market indices over the last 12 months*.

Is now a good time to invest in South Korean equities?

Looking at valuation alone, the market looks attractive. A recent report from Goldman Sachs Asset Management shows that, over the next 12 months, South Korea’s anticipated earnings growth is in ninth place out of the 24 largest emerging market economies. Not only this, but there are only two other country-specific emerging markets within this list (Russia and Turkey) which look cheaper on a valuation basis**.

Matthew Vaight, manager of the Elite Rated M&G Global Emerging Markets fund, is positive on Korean equities. While other rallies have been driven by momentum recently, he said the Korean market has thrived because of attractive fundamentals. This, according to the manager, provides a solid foundation for the index to keep outperforming.

“In our view, the fact investors have still not been willing to pay a higher price for shares means the ‘South Korean discount’ remains intact,” he said.

“Despite economic reforms – which are centred around corporate governance and aim to increase South Korea’s growth rate to 4% and employment to 70% – a majority of investors seem to be sceptical of the sustainability of them. I disagree.”

Sharat Shroff, manager of the Elite Rated Matthews Asia Pacific Tiger fund, is currently increasing his exposure to South Korea. He says sentiment towards shareholders and corporate governance in the country is indeed improving, having mostly been led by KOSPI giant Samsung.

The Guinness Asset Management team – which runs the Elite Rated Guinness Global Equity Income fund – pointed out that North Korea and South Korea have announced a joint summit for the 27 April, which suggests improving relations between the two countries.

“In addition to the de-escalation in tensions over North Korea, we note further progress in corporate governance in South Korea,” it said. “The country’s Fair Trade Commission has ordered its largest conglomerates to simplify their ownership structure without negatively impacting minority shareholders.”

Of course, the market is not without its headwinds. Tensions between North and South Korea – even though they appear to be improving – still need to be kept a close eye on.

South Korea could also be negatively impacted by further US interest rate hikes over the course of 2018. This is because it will widen the value gap between the US dollar and and Korean won, which could hurt Korea’s exporting businesses.

That said, we believe this area of the market is attractive from a valuation perspective and, for those willing to take on the risk, could present strong returns over the long term.

*Source: FE Analytics. Total return in sterling terms. Correct as of 18 April 2018.

**Source: GSAM. Forward price earnings over 12 months.