Investing Gangnam style
Well before the popular ‘Gangnam style' video went viral on the internet, South Korea had found a place in the new world order.
For those not plugged into the pop rock scene, the punchy music video set YouTube download records poking fun at the flashy nouveau rich residing in Seoul's tony Gangnam district.
Over the past several years, Gangnam has developed into an icon of fashionable living within South Korea's bustling capital city.
The new found prosperity concentrated here perhaps best epitomises the rapid economic growth of an emerging nation which in many respects has already emerged.
While analysts remain divided over whether or not South Korea is technically a so-called ‘developed country' right now, it would be hard to argue that the rising Asian tiger is not currently an important player on the global economic stage.
Lately, the nation has come into its own as the world's 15th largest economy ranked by nominal GDP and eighth largest product exporter. South Korea, which hosted the G20 economic summit in 2010 has fostered well regarded companies with globally recognised brand-names including Samsung, Hyundai and LG electronics.
In contrast to neighbouring China which has been challenged to create value-added products, many of South Korea's products command premium prices, adroitly stealing mind and market share from formidable corporate titans based in the US, Japan and Europe. For example, Samsung's Galaxy smart phones and tablets have put the hurt on vaunted Apple Inc. Industry analysts believe the increased competition from Samsung to be a key reason why Apple's revenues and earnings have fallen short of expectations over the past year.
But what makes South Korea a potentially unique investment opportunity is that the country's securities often behave like emerging market listings despite the nation's progress.
Even the index providers, presumably experts on the subject, cannot agree.
At the moment, both FTSE and Standard & Poor's classify Korea as developed market, but Morgan Stanley still classifies the nation as a developing country lumping it into the same category as Indonesia and the Philippines.
While there is no precise definition of what constitutes a developed economy, the term refers to a country with a relatively high level of economic growth and prosperity.
Some of the key elements for measuring this prosperity include the nation's per capita income, solid infrastructure, a growing gross domestic product (GDP) and a generally higher standard of living.
Increasingly, other non-economic factors are considered such as the Human Development Index (HDI) which considers relative levels of education, literacy and health.
Korea is ranked 12 out of 187 on HDI and is also ranked relatively high on the other factors.
One advantage of Korea's ambiguous classification is that dislocations in the often volatile emerging market sector frequently create attractive entry points.
When investors pull funds out of the EM sector en masse as they did over this past summer, proverbial babies are inevitably thrown out with the bathwater.
In early July bond managers and Electronically Traded Funds (ETF's) were forced to liquidate emerging market positions when investors panicked over rising US interest rates and began moving funds into larger currencies such as the greenback.
This broad EM sector dumping allowed us to buy South Korean agency paper at some of the most attractive levels seen in the past year. Already, this has proved to be a profitable trade as credit spreads have since tightened back in and most Korea bond prices have ticked higher
Despite the recent disruptions in the emerging market sector, Korea stands out as creditworthy sovereign. In recent years, the major credit rating agencies have been perhaps overly aggressive — not hesitating to downgrade any entity in this age of tougher credit standards. Yet amid a swath of country credit downgrades including the UK, the US and France, Korea's sovereign debt has actually been steadily upgraded. Standard and Poor's upgraded Korea from A to A+ late last year while at the same time, Moody's upgraded the country a notch higher from A1 to AA3.
Moody's stated the higher rating reflects an “assessment of four factors: very high economic and government financial strengths; high institutional strength; and moderate susceptibility to risks from financial, economic, and political events.” The agency noted that Korea's economic fundamentals and policy framework have “improved materially since the global financial crisis and expects overall continuity in economic policies and economic growth to strengthen to between 2.5% and 3.5%, in 2013 and in 2014, respectively.”
While the future continues to look promising for South Korea as an economy, the landscape is not entirely perfect in our opinion. Exports can be a two-edged sword and what presently accounts for almost half of South Korea's GDP can also be a fiscal drag at times. Growth faltered somewhat last year during the euro zone's extended recession for example. Perhaps more troublesome is Japan's new leadership under Prime Minister Shinzo Abe who has pledged to drop the value of Japan's currency in order to make its products more price competitive. What had been a nice currency tailwind over the past few years may turn into somewhat of a headwind as many South Korean companies in the auto and technology sectors compete directly with Japanese products.
On the domestic demand front, South Korea has one of the highest levels of per capita disposable income in Asia. However, some economists believe the middle class is struggling in part because Korean government policy has historically tended to favour its large corporations or ‘chaebols' over individuals. The chaebols often act like large, private companies whose interests are not always aligned with shareholder's objectives. And finally, North Korea's new leadership and persistent sabre rattling could be a source of trouble at some point down the road.
Notwithstanding some immediate and longer term challenges, we believe Korea's equity and bond markets deserve to be on investors' radar screens. On a valuation basis, Korea's stocks are relatively inexpensive using traditional metrics. Korea's price-earnings ratio is presently just 14X versus the S & P 500's ratio of 16X, or about a 13% discount despite having a meaningfully higher growth rate. Year-to-date the MSCI South Korea stock index has substantially lagged the US based markets. The Korea index remains essentially flat year-to-date compared to the S & P which is up over 20% so far. Investors not wishing to chase America's soaring stock market might consider looking here.
Bryan Dooley, CFA is a senior portfolio manager at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information.
This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.