From pop groups, TV shows, cars, home appliances, electronics and smartphones, South Korean brands have for years been familiar to global consumers. Millions of homes are filled with Smartphones and TVs made by Samsung Electronics (005930:KRX) and LG Electronics (006657:KRX), cars made by Hyundai Motor (005380:KRX) and Kia (000270:KRX), while microchips made by Hynix (000660:KRX) power these gadgets and goods.

Yet its stocks have spent years underwhelming global investors, the nation’s KOSPI Composite Index lagging the MSCI All-Country World Index for much of the last 15 years, creating the ‘Korea discount’.

‘South Korea has for years been the cheapest equity market in Asia, and even the world,’ says Will Lam, co-head of the Asian and Emerging Markets Equity team at Invesco and manager of the Invesco Asian UK (B8N44Q8) fund.

ROOTS OF THE ‘KOREA DISCOUNT’

Many analysts portray this discount as resulting partly from the ever-simmering tensions with North Korea, which are unlikely to ease for the foreseeable future. Others think there underlying corporate issues that continue to hobble stock prices,

‘Many companies sit at a price-to-book ratio below 1.0 and are known to have historically placed little emphasis on shareholder return policies, including dividends and buybacks, and to have questionable corporate governance,’ says Josef Licsauer, analyst at Kepler Trust Intelligence.

Inefficient asset utilisation and capital allocation is complicated by corporates web of cross company shareholdings, while critics say too much power is wielded by company founding families intent on capping inheritance tax bills.  

‘Much like Japan has family-run conglomerates known as zaibatsu, South Korea has family-run conglomerates called chaebols, including companies like Samsung and LG Electronics,’ says Kepler’s Licsauer. ‘They are often accused of ignoring the interests of other shareholders, keeping share prices artificially low to avoid Korean inheritance tax, which is among the highest in the world.’

South Korea wants this to change. Taking pages from Japan’s years long corporate reforms playbook, in February 2024 the country launched the corporate ‘Value Up’ programme. It aims to home in on companies with low price to book valuations, just as Japanese reforms do, and to hold management more accountable for improving governance.

‘The high-level roadmap suggests the programme will be incentive-based and focused on strengthening governance, not on punitive measures,’ say analysts Fisher Investments, meaning investors are more likely to see tax incentives for companies that participate rather than threats of delisting or other penalties.

INITIAL EXCITEMENT FIZZLES OUT

Anticipation of these changes saw global investors pour money into South Korea’s stock market in the hope that a government push on this scale will boost depressed valuations. Kepler believes managers of JPMorgan Global Emerging Markets Income (JEMI) trust have increased exposure to South Korea, having effectively been structurally underweight for many years.

But with ‘Value Up’ details still vague and subject to change, the influx of capital to the Korean stock market has proved short-lived, the index drifting since March highs.  

‘The KOSPI Index fell the morning of the announcement, with losses led by automakers and banks, sectors that had rallied hard ahead of the government’s reform proposal,’ notes Kepler’s Licsauer.

‘We think this is because the incentives need legislative approval, which opens them up to execution risks and the potential for disappointment,’ say Fisher Investments analysts.

MAJOR QUESTIONS REMAIN

Without even a draft law available yet, can it even pass? How generous will it be? And can that overcome the presumable opposition from vested interests? Looming over these questions is the Yoon administration’s flagging popularity, which contributed to his conservative People Power Party’s defeat in 10 April legislative elections. 

‘While Yoon’s presidency wasn’t up for a vote, the PPP’s failure to take control of Korea’s National Assembly from the progressive Democratic Party could determine the Corporate Value-Up Program’s success or failure,’ says Fisher Investments.

However, it’s important to remember that Japan’s governance successes were a result of efforts spanning over a decade. ‘We hope to see South Korea’s discount unwind over the next decade, although there is not much evidence today,’ the Invesco’s Lam says.

‘We think this is a promising start from South Korea and a step in the right direction, and ultimately leads to some interesting opportunities that may be flying under the radar, something a number of fund managers we’ve spoken to recently are seeing,’ says Kepler’s Licsauer.

He flags the Templeton Emerging Markets (TEM) investment trust as another option for gaining exposure to South Korea. ‘The managers, Chetan Sehgal and Andrew Ness, are currently overweight South Korea, versus the MSCI Emerging Markets Index, but have trimmed exposure given its recent market rally.’

ETFs offer investors another option on South Korea, including iShares MSCI Korea (CSKR), which is one of the larger options at a 0.65% annual charge (on the high side for a tracker fund).

Investors may also feel that emerging markets funds will give them plenty of exposure, although you’ll need to do some checking since unlike MSCI, FTSE doesn’t class South Korea as an emerging market.

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