Korea – Risk & opportunities
South Korea always remained a source of opportunity. President Park Geun-hye has been impeached and removed from office, while tensions on the Korean peninsula have been ratcheted up by North Korean belligerence and US sabre-rattling, with a related Chinese boycott of all things South Korean. So, is South Korea still attractive, particularly given that against this backdrop its equity market has been one of the best performing in Asia so far this year?
Firstly, I want to consider the question of geopolitical tensions. That South Korea’s equity market has performed so strongly at this time reflects the reality that investors have become accustomed – immune if you like – to negative headlines on North Korea, and any related market sell-offs have always been very short-lived. This apparent market complacency makes me slightly uneasy, but we continue to believe that there is only a very small probability of there being major disruption in the medium-term. The discount which the market seems to be applying to South Korea to allow for ‘North Korea risk’ is more than adequate in our opinion.
Secondly, it is worth pointing out that Samsung Electronics has been by far the biggest contributor to the Kospi index’s performance year-to-date. The company has a weighting of around 25% in its home market, and it reported a strong set of quarterly earnings in April. While positive earnings revisions have been the biggest share price driver, sentiment towards the company has also benefited from the successful launch of the Galaxy S8 smartphone and continued positive actions to improve shareholder returns. For example, Samsung recently decided to cancel W49 trillion (£34bn) of existing treasury shares, concentrating ownership rights in the remaining shares.
South Korea’s equity market has historically traded at a discount to other Asian markets, partly due to geopolitical tensions with North Korea, but largely due to its reputation for poor corporate governance. However, there is a real prospect that other Korean companies will start following Samsung’s lead in recognising the importance of shareholder returns. It is also worth noting that President Moon Jae-in was elected on a promise to pursue chaebol reform, which could provide a catalyst for companies to start improving capital allocation decisions. We believe that the market is underappreciating what could be a very positive trend, but caution this view with acknowledgment that progress is likely to be gradual.
Finally, we are still able to find attractive opportunities in South Korea. The holdings we introduced into the Invesco Perpetual Asian Fund during the latter half of 2016, such as LG Corp and E-Mart, have outperformed so far this year, but we still believe that the wider Korean equity market remains unloved and cheap. We have added to existing holdings that have lagged the broader market’s rise and introduced a new holding in LG Uplus, a telecoms company which is trading on a low multiple of free cash flow and benefiting from strong growth in demand for mobile data.
We remain wary of geopolitical risk in Korea and the possibility that widespread improvement in corporate governance remains a hope rather than reality. However, while the market has performed strongly so far this year, stock valuations have been rising off a low base, and we continue to feel that the country remains an attractive place to invest.
William Lam, fund manager, Invesco Perpetual’s Asian Equities