KF - The Korea Fund: Accumulate Following H1 2023 Macro Weakness

2023-07-13 06:21:55 ET

Summary

• The Korea Fund is a good vehicle for gaining exposure to South Korea's stock market, especially in July when the discount is near a historical low.
• Despite underperforming the iShares MSCI South Korea ETF, KF can outperform during bull markets, having done so by over 10 percentage points in the past year.
• South Korea's economy faces headwinds with declining exports, but there are opportunities in the country's larger tech and consumer stocks, as well as in its banking sector.

Korea Fund Opportunity Overview

The Korea Fund ( KF ) is one of the best vehicles to consider if you want to gain exposure to South Korea’s stock market. July is a good time to continue accumulating shares, as the discount is near a historical low.

The main risk to consider is that South Korea’s economy could face multiple headwinds this year, as exports have been declining significantly so far. Growth will likely be lackluster in 2023 and 2024.

However, the equity market is likely due for a rerating from investors, as South Korea still trades at a discount to some smaller Asian emerging markets.

This fund has underperformed the iShares MSCI South Korea ETF ( EWY ) in the past month. However, the Korea Fund can be a better vehicle during bull markets, as it outperformed this ETF by over 10 percentage points in the past three years.

Taking Advantage of the Discount

The discount of the Korea Fund is still attractive on a historical basis. This fund currently trades at a 15% discount to NAV, compared to its 52-week low discount of 11.06%.

I also previously noted how this discount was relatively significan t, as other closed end funds typically trade at around a 10% discount to NAV.

As you can see, this ETF tends to outperform other ETFs during bull markets, although it sometimes experiences stronger drawdowns when the market corrects. As sentiment recovers in South Korea and emerging Asian markets, I think this fund could trade at a 10% discount to NAV.

Not So Emerging

South Korea’s valuation has increased substantially ( at around 11x PE in my last coverage) since I last covered this fund, yet its valuation is still in line with MSCI Emerging markets. Other markets like Thailand and Malaysia trade at 16-20x earnings, even though both countries have smaller capital markets and less developed economies.

South Korea's economy and capital markets are ahead of other emerging markets in many aspects. However, South Korea still retained its emerging market classificatio n during MSCI’s recent semi-annual review.

Source: Bloomberg/CEIC/various

One of the main factors holding it back from an upgrade include its decision to ban the short selling of certain stocks. South Korea is in good shape regarding other requirements, such as market size/liquidity and economic development.

A recent Economist article noted that South Korea is the world’s 12th largest economy, and the average salary is $35,000, on par with countries like Italy. Moreover, the IMF has classified it as a developed country since 1997.

I retain the view that South Korean equities should trade at a slight premium to MSCI Emerging Markets. An upgrade to developed market status would be the final piece for a full upgrade and higher valuation.

Export Decline Pushes Country Near a Recession

South Korean equities are attractively valued from a relative value standpoint, but macro headwinds this year could result in short term pullbacks. Positive points for the economy include China's economic rebound earlier this year , and the fact that South Korea has strong exposure to Asia and relatively low exposure to Europe.

South Korea’s economy only expanded by 0.3% in Q1 2023 , following a contraction of -0.4% in the previous quarter. Although South Korea’s exports grew by over 6% in 2022 , export growth has come under pressure in recent months.

South Korea’s exports have declined for nine consecutive months. Export growth may be relatively flat this year, and it may not be until 2024 until its export growth fully recovers.

South Korea Export Growth

Most of South Korea's top trade destinations include regional peers, and it has very little exposure to Europe's economy. Vietnam was South Korea’s largest importer in 2023 . Its top two export destinations typically include the United States and China, and it primarily exports electronics.

South Korea's economy was able to dodge a recession this quarter, and growth will likely be around 1-2% this year. Its Central Bank has successfully lowered inflation to below 3% and will not likely have to hike rates this year.

Outlook

Most countries in this region, including Taiwan, will likely face slower growth this year due to weaker global demand for electronics and other products these countries export to. Therefore, there will likely be many opportunities later this year to accumulate.

The Korea Fund is a superior vehicle, as you can access some of the larger tech and consumer stocks at a discount. There is also deep value in other parts of South Korea’s economy, mainly in its banking sector. South Korea also plans to open up its banking sector for the first time in 30 years , allowing new domestic entrants to more easily enter the industry.

South Korean banks have underperformed in the long run but are attractively valued at the moment.

I will likely accumulate a combination of South Korean banks and this closed end fund in H2 2023. Recession fears are likely overstated, and South Korea has a relatively superior export structure. The global electronics has strong growth potential in the long run , and a rebound could help South Korea's economy recover in 2024.

South Korea's stock market has been resilient this year, despite weakening exports, and the market trades at a discount to all of these emerging markets. South Korea likely has room to outperform other markets in the long run if the market begins to trade at a premium to MSCI Emerging Markets.

Until this valuation gap closes, I will continue to prefer South Korea over other Asian emerging markets.

Another catalyst would be the potential rerating of South Korea's stock market in 2024 or later. I am monitoring this in the event that any changes are made in the market that MSCI notices in 2024 reviews.

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