KF - Korea Fund: Rare Opportunity To Pick Up Quality On The Cheap

Summary

• Notwithstanding the weakness this year, Korea Fund has been a long-standing source of alpha for investors.
• Korea Fund’s current valuations are dirt cheap, and Korea’s impetus toward innovation and R&D is unrivalled.
• The won looks oversold and could benefit from the dollar’s recent pivot.

The Korea Fund ( KF ) is a long-standing closed-end fund ("CEF") that focuses on around 50 Korean companies which are listed on the Korean Stock Exchange. As you can see from the image below, KF has proven to be a tremendous source of alpha over the years, delivering returns of nearly 3.5x that of the Vanguard Total International Stock Index (VTIAX).

Nonetheless, 2022 has been a brutal year for KF, as it has lost 40% of its value on a YTD basis. Given the annihilation witnessed this year, I can understand if investors are cautious at contemplating a product of this sort, but I believe there are a few promising factors that are worth considering.

Why KF?

Lest we forget, Korea is still one of the nations that devotes enormous resources towards developing a sustainable, innovative culture. Just for some context, other than Israel, no other nation spends a greater proportion of their GDP on R&D than South Korea, at around 4.5% of GDP.

Separately, Bloomberg also ran a study measuring various countries based on parameters ranging from R&D intensity, value-added manufacturing, high-tech density, researcher concentration, and patent activity. All these metrics were aggregated to determine a comprehensive innovative score, which South Korea ended up topping, with a value of 90.49.

In recent years, we've also come across a lot of brouhaha from the next frontier in technology services- the metaverse. Hitherto, interest has largely been limited to the corporate world, but as noted in The Lead-Lag Report, from a country-wide perspective, South Korea appears to be at the vanguard of this movement. It could well make a mark given its first-mover advantage in this field.

Whilst the government plans to initially deploy around $177m across the country, at the city level, Seoul's metropolitan government plans to engineer a 3.9bn won metaverse platform to facilitate public service access on a virtual basis.

You could have bumps along the road, but all in all, I believe there is ample merit to be gained in devoting a portion of a portfolio to an innovative nation of this sort, as it will serve as one of the prime hotbeds for fueling the world's future growth.

What makes this opportunity particularly tantalizing is that on account of the significant correction this year, you could gain access to Korean companies, via KF, at an enormously low forward P/E of less than 8x.

In the short term, KF may continue to face some pressure on account of slowing export momentum, particularly in its arch specialty - the chip sector - for which it is renowned for. After witnessing double-digit growth for two successive years, the global semiconductor market will only likely grow at a minuscule rate of mid-single digits in 2023.

Weak demand conditions mean you're likely to see a significant curtailment in production and shipments, particularly as inventories in Korea are quite elevated by historical standards. It's worth noting that factory shipments have been on a declining trend for two successive months now.

One company that could feel the effects of this quite profoundly is Samsung Electronics ( SSNLF , SSNNF ), which also incidentally is KF's top holding by far, with an individual weight of 22%. The company is a noted player in the DRAM market, and this is a market that will engage in quite a bit of inventory readjusting over the next few quarters.

Nonetheless, it isn't all doom and gloom for Samsung Electronics, and if you're willing to take a longer view, there's still much to admire. The company began the manufacture of its 3nm chips by the end of Q2 and is currently in discussion with the likes of Qualcomm (QCOM), Tesla (TSLA), and AMD (AMD). For the uninitiated, it is also in a neck-to-neck race with Taiwan Semiconductor Manufacturing Company Limited (TSM) to manufacture the most advanced chips (2nm and 1.4nm) and recently unveiled aggressive plans to begin the process by 2025. Analysts from Daiwa Capital markets believe that Samsung Electronics' ambitions look a lot more aggressive than what TSMC has postulated.

Finally, I also want to touch upon the FX angle which could abet KF's prospects. Outside the yen, no other Asian currency has been decimated as much as the Korean Won this year. I believe this could change here.

Those who subscribe to The Lead-Lag Report will acknowledge that I've been debating the prospects of the government stepping in to save the bond market. This would, in theory, put a ceiling to the dollar's meteoric rise and provide a perfect fillip for a melt-up rally, particularly in some of the beaten-down EM currencies such as the Won. We've already seen the dollar index correct from 114 last week to 100, and as dovish conditions continue to get priced in, expect further weakness.

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