Korea cannot be accused of keeping a low profile in 2018. From the elation of the Winter Olympics to the terror of a possible nuclear war, both North and South have dominated the headlines.
While the world’s attention is understandably focused on the politics of the North, the South is quietly undergoing a significant economic shift.
Over the past two decades, South Korea has climbed the ladder to become the world’s 11th largest economy by GDP, according to the World Bank and the Organization for Economic Co-operation and Development.
A key driver of that growth has been the large family-owned corporations known as ‘chaebols.’ These conglomerates, which include household names such as Samsung, Hyundai, SK, LG and Lotte, have transformed the country into the world’s sixth largest exporter. They also represent more than 50% of the country’s GDP. ‘Chaebols dominate the Korean economy,’ said Alvin Potin, manager of the American Century Non-US Intrinsic Small Cap Value strategy.
While these firms have undoubtedly helped South Korea, South Korea has also helped them. The chaebols have historically relied on the government to design laws in their favor, Potin explained. But the system that once propelled South Korea’s economy has hindered its growth of late, Potin added. ‘This cozy relationship between corporations and the government has resulted in massive corruption and corporate misgovernance,’ he said.
One example of this was exposed in late 2016 when it emerged that Choi Soon-sil, an aide to then-president Park Geun-hye, used her position to seek donations from chaebols to foundations that she controlled. It was then revealed that this same aide, who did not have an official position, had influence over government policies and access to the president’s speeches. Following the scandal, Park was impeached and the new government promised reform of the chaebols.
In August last year, head of Samsung Group, Jay Y. Lee, was sentenced to five years in prison after he was convicted of bribery to gain greater control of the empire founded by his father. The founder of Lotte retail group was also sentenced to four years in jail for embezzlement in December 2017.
Reform of these companies, including their relationship with the government, ownership structures and accountability to smaller shareholders should be a boon to investors, Potin said. ‘This culture of cronyism is the reason why Korea is trading at a major discount of 25% [relative to regional peers],’ he said. ‘It is the cheapest emerging market out there.’ MSCI currently classifies South Korea as an emerging market, while FTSE Russell and S&P consider the country a developed market.
Potin is not the only manager to have noticed the discount. We have run the numbers on all international funds across market cap and style categories to see which have the most exposure to the country.
The Templeton Foreign fund has the largest allocation at 8.7%, more than double the MSCI All ACWI ex-USA’s 3.7% as of February 28. The $7 billion fund takes a bottom-up approach and a value tilt. The fund’s management team – Tucker Scott, Norman Boersma, James Harper, Heather Arnold, Christopher James Peel and Herbert Arnett – invested in Samsung in 2010 and holds seven other South Korean companies in the financial services, consumer and industrials sectors.
For 2017, the fund’s overweight to South Korea was the highest contributor to returns, boosting performance by 4.81% – more than any other country represented in the portfolio and primarily driven by top holding Samsung.
The fund has a 6.8% position in the country, the bulk of which is in Samsung.
Not listed here because it is not available as a mutual fund, Potin’s American Century Non-US Intrinsic Small Cap Value strategy is perhaps South Korea’s biggest cheerleader, with a 14.3% position in the country at the end of 2017. Unlike the other funds listed here, Samsung is not its top position; instead, that is Kia Motors Corp.