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Why North Korea-South Korea deal would boost investor outlook

David Brenchley  |  01 May 2018Text size  Decrease  Increase  |  
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Korea unification, Kim Jong-un, Moon Jae-in, South Korea, North Korea, emerging markets

Friday marked the first time a North Korean leader had set foot across the Military Demarcation Line and into South Korea since the Korean War in 1953. The historic meeting between Kim Jong-un and Moon Jae-in culminated in an agreement from both sides to work to de-nuclearise the Korean Peninsula.

But what of the investment case for South Korea? The country’s stock market accounts for 15 per cent of the MSCI Emerging Markets Index and 17.5 per cent of the MSCI Asia Pacific ex Japan Index. Its largest constituent, Samsung Electronics is the second largest firm in both indices.

The Morningstar Korea Index is one of the best-performing year-to-date, up 2.34 per cent. The KOSPI Index is currently 38 per cent up from its early 2016 low.

The economy continues to improve. It’s now the third-largest in South East Asia and in the three months to September 2017 its economy grew by 1.5 per cent, its best rate of growth since the second quarter of 2010.

Clearly any thawing of tensions between the two sides would be welcome. But that’s unlikely to alter the investment case for the country, according to fund managers. What is driving increased confidence in South Korea is changes to corporate governance practises.

Korean stocks fail to deliver dividends

South Korea has long traded on cheap valuation multiples compared to its neighbours, partly as a result of political tensions but more pertinently because of historically poor governance at many chaebols – Korea’s big, family run business empires.

The Korean market has the lowest payout ratio of any major stock market in the world – at around 24 per cent - despite its companies being highly cash rich. "A lack of effective oversight has allowed company managers to simply hold cash back from shareholders," says James Syme, manager of UK-based JOHCM Global Emerging Markets Opportunities Fund.

But that’s changing. The current Liberal government has introduced a stewardship code, meaning reforms similar to those occurring in Japan are improving the environment for shareholders. Chaebols, or Korean large industrial conglomerates, are coming under increasing pressure to up their dividend payout ratios.

These reforms worked in Japan, boosting valuations on those firms that bought into the code, says Ben Surtees, manager of the UK-based Jupiter Asian Fund. "Like in Japan, I’m confident the code will also force many Korean companies to relinquish their poor governance practises, which should help improve valuations," he adds.

Syme says these reforms are needed, as the ageing population in Korea means income is needed more than ever, resulting in the lack of dividends becoming a growing issue in Korean politics.

However, he doesn’t dismiss the potential benefits reunification could have on the long-term economic outlook. Drawing on the example of East and West Germany coming together, he notes that it could be negative in the short term.

However, North Korea has many attractive traits for South Korean firms to draw on, including a large pool of cheap labour that is keen to work. It could also open up trade routes from Seoul to Beijing and through to Moscow and the Middle East.

Surtees concludes: "The short-term consequences would be an extremely bitter pill to swallow for South Koreans and investors alike. But in much the same way that Germany now dominates Europe, Korea could occupy a similar position in Asia in the future."

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David Brenchley is a reporter for Morningstar UK.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is a Reporter for Morningstar.co.uk.

© 2019 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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