An investment fund offering a double discount on South Korean stocks

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South Korea occupies an unusual place in world markets. It is a rich and innovative economy that is home to large international groups – such as Samsung, LG and Hyundai – which hold strong positions in key industries. Yet the market is still cheap in nominal terms. The MSCI Korea Index is trading at 7.8 times earnings forecast, compared to 14.5 for the MSCI World.

There are several reasons why its valuation is so low. Corporate governance remains an issue: conglomerates controlled by families (chaebol) dominate the economy and many of them have not always treated minority shareholders fairly. The stock market is still classified as emerging by MSCI – whose developed and emerging indices have a huge influence on how much you invest where – due to trading restrictions. Many large companies operate in cyclical sectors and cyclical stocks trade at a lower price than defensive stocks. And in the past, the presence of nuclear-armed North Korea just across the border was another risk, but maybe in today’s world it’s a less idiosyncratic peril than before.

However, governance is improving and promotion to developed country status is eventually to take place, so it seems plausible that Korea will one day trade at a higher valuation. The Weiss Korea Opportunity Fund (Goal: WKOF) offers an unusual way to support this idea.

Buy at a discount

WKOF invests only in Korean preferred stocks (prefs). They are not preference shares in the standard British sense of shares that pay a fixed dividend: in Korea, preference shares are generally non-voting shares with a variable dividend which is usually very slightly higher than that of ordinary shares, but which otherwise represent a standard participation. Preferences were typically issued about three decades ago when founding families wanted to raise more capital without giving up control. According to WKOF, there are around 123 outstanding issues, ranging from Samsung Electronics to obscure companies best avoided.

Buying shares without voting rights may seem more risky, but in Korea a founding family usually has enough voting rights to be in control, so an investor in preferences is not obviously disadvantaged by compared to minority investors in ordinary shares. In the past, investors in preferences have been treated the same as those in common stocks, says Mark Lewand, head of investor relations at Weiss. Therefore, Korean Preferences should not necessarily trade at large discounts to common stocks.

Despite this, many do, which creates two opportunities. First, Korean blue chips are already trading cheaper than their comparable global counterparts. Thanks to the preferences, investors can buy with a double discount, explains Jack Hsiao, director of WKOF. Second, discounts are changing in response to corporate restructuring and better governance. A decade ago, Samsung Electronics’ preferences traded at a 40-50% discount, but this has dwindled to around 10%. WKOF has moved from Samsung to other top preferences with deeper discounts, such as Hyundai Motor, where such catalysts have yet to play.

Respectable returns

WKOF has returned 123% in terms of net asset value (NAV) since its inception in 2013, compared to 50% for MSCI Korea. Dividends are paid annually, with a yield of 3.5% at Monday’s close of 181p. The expense rate is 1.8%, including 1.5% management fees. A discount control mechanism keeps the discount fairly tight (2.2% on Monday). However, it is a small fund (assets of £127m) and the bid/offer spread may widen under these market conditions (now around 5%).

WKOF is a fund specializing in a single country and not for all portfolios. Still, it looks cheap. Its preferred portfolio’s discount to equivalent common stock is now 52%, as wide as it has been since 2013, putting it on less than five times earnings. If you expect Korea to revalue higher, this should be a good time to remember and a good time to start buying.


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