South Korea occupies an unusual place in global markets. It’s a wealthy, innovative economy that’s home to major international groups – such as Samsung, LG and Hyundai – that have strong positions in key industries. Yet the market is consistently cheap in nominal terms. The MSCI Korea index trades on 7.8 times forecast earnings, against 14.5 for the MSCI World.
There are several reasons why it’s on such a low valuation. Corporate governance remains an issue: family-controlled conglomerates (chaebol) dominate the economy and many have not always treated minority shareholders fairly. The stockmarket is still classed as emerging by MSCI – whose developed and emerging indices have a huge influence on how much gets invested where – due to trading restrictions. Many big firms operate in cyclical industries, and cyclical stocks trade at a discount to defensive stocks. And in the past, the presence of nuclear-armed North Korea just across the border stood out as another risk, but maybe in today’s world that’s a less idiosyncratic peril than it used to be.
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Buying at a discount
WKOF invests solely in Korean preference shares (prefs). These aren’t prefs in the standard UK sense of shares that pay a fixed dividend: in Korea, prefs are typically non-voting shares with a variable dividend that’s usually very slightly higher than the ordinary stock, but otherwise represent a standard equity interest. Prefs were typically issued around three decades ago when founding families wanted to raise more capital without giving up control. There are around 123 issues outstanding, says WKOF, ranging from Samsung Electronics to obscure firms that are best avoided.
Buying into non-voting shares may seem riskier, but in Korea a founding family typically holds enough of the voting rights to have control, so an investor in prefs isn’t at an obvious disadvantage to minority investors in common shares. In the past, investors in prefs have been treated equally to those in common shares, says Mark Lewand, head of investor relations at Weiss. Hence Korean prefs shouldn’t necessarily trade at big discounts to common stock.
Despite that, many do, which creates two opportunities. First, Korean blue chips already trade cheaper than comparable global peers. Through prefs, investors can buy in at a double discount, says Jack Hsiao, WKOF’s manager. Second, discounts change in response to corporate restructuring and better governance. A decade ago, Samsung Electronics’ prefs used to trade at a 40%-50% discount, but that has narrowed to around 10%. WKOF has rotated out of Samsung into other blue-chip prefs with wider discounts, such as Hyundai Motor, where such catalysts have yet to play out.
Respectable returns
WKOF has returned 123% in net asset value (NAV) terms since its inception in 2013, against 50% for the MSCI Korea. Dividends are paid annually, with a trailing yield of 3.5% on Monday’s close of 181p. The expense ratio is 1.8%, of which 1.5% is the management fee. A discount control mechanism keeps the discount fairly tight (2.2% on Monday). However, this is a small fund (assets of £127m) and the bid/offer spread can widen in these market conditions (now around 5%).
WKOF is a specialised single-country fund and not for every portfolio. Still, it looks cheap. The discount of its prefs portfolio relative to equivalent common shares is now 52%, as wide as it’s been since 2013, putting it on less than five times earnings. If you expect Korea to rerate upwards eventually, it should be one to hold and a good time to start buying.
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