South Korea has been one of our favorite emerging markets for years. It will soon be in the spotlights, hosting the Winter Olympics in PyeongChang from 9 to 25 February. To us, South Korea is always in the spotlights, being one of our key holdings in our emerging markets equities portfolios. This has paid off and today, the investment case for this country is still solid.
South Korea’s rise started under President Park Chung-Hee, who governed the country from 1963 to 1979. One of President Park’s main objectives was to eradicate poverty. To achieve this, he industrialized the country, with an important focus on exports. Under his leadership big conglomerates, called chaebols, such as Samsung, Hyundai, and Lucky Goldstar (LG) emerged.
Unfortunately, in 1972 President Park effectively became a dictator by dissolving the legislature, which ultimately led to his assassination in 1979. Today, South Korea is still an export-driven economy. According to the Bank of Korea, exports accounted for 55% of GDP over 2017.
Since the Olympics in Seoul in 1988, South Korea has emerged stronger from two major crises. The first one was 1997’s Asian Financial Crisis, which caused the bankruptcy of several large corporations. The International Monetary Fund provided a USD 57 billion bailout package, demanding restructuring measures in return.
Another consequence was the fall of the South Korean won from some 850 per US dollar at the end of 1996 to nearly 2,000 per US dollar in December 1997. This is why to date, the Bank of Korea is still very strict when it comes to trading the won. And this is precisely one of reasons why MSCI has still not upgraded South Korea to developed market status, stating that “the lack of an offshore currency market and constraints on the onshore currency market continue to present operational challenges for investors.” Therefore we do not expect the country to be promoted to developed market status in the near future.
In 2007-2008, South Korea faced a second major crisis: the Global Financial Crisis. According to the Bank of Korea, GDP growth dropped from 6.3% year-on-year over the fourth quarter of 2007 to -1.9% over the first quarter of 2009. The MSCI Korea plummeted by 55% in US dollar terms over 2008, which was slightly worse than the MSCI Emerging Markets return of -53%. This time too, South Korea managed to fully overcome the crisis. From 2009 to 2017 the MSCI Korea index recorded a return of 14% per year in US dollars, against 11% for the MSCI Emerging Markets index. The table shows that, in the majority of the years since the Global Financial Crisis, South Korea has outperformed the emerging markets universe as a whole.
Despite these stock market returns, the South Korean stock market still remains relatively cheap. As shown in the Price-Earnings (PE) graph below, stock market returns are backed by corporate earnings growth. As a result, the MSCI Korea index still only trades at 9.4x PE 2017 and 8.4x PE 2018, which is much lower than the MSCI Emerging Markets average of 14.0x PE 2017 and 12.4x PE 2018. Two main reasons for this ‘Korean discount’ are the tensions between North and South Korea, and corporate governance.
Tensions with North Korea have been increasing after a series of nuclear and missile tests. However, the latest developments are positive, as both Koreas have started to talk again to ease military frictions, and North Korea will send a delegation to the Winter Olympics in PyeongChang. Nevertheless, we do not expect the political situation to change, which means that, like in the past, we will see a rise in political tensions every once in a while.
After some headline-grabbing scandals, South Korean companies have started to improve their relatively poor corporate governance. A major scandal, for example, was the impeachment of President Park Geun-Hye, daughter of former president Park Chung-Hee, in late 2016, for having sought ‘donations’ from several business conglomerates.
These scandals, which exposed South Korea’s underlying problems, have set off a series of positive developments on the corporate governance front. The National Pension Service of Korea, which owns around 10% of the Korean equity market, has pledged to adopt the Stewardship Code, which encourages responsible investment among professional investors. Samsung Electronics has become much more shareholder-friendly by canceling all treasury shares, which are the shares it kept in its own treasury. In addition, the company has committed to return over 50% of free cash flow to shareholders via dividends and share buybacks, and has appointed a completely new top management, splitting the Chairman and CEO roles. And these are just a couple of examples of the positive trend in corporate governance in South Korea.
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