End of Korean War Might Spark End to `Korea Discount' for Stocks

(Bloomberg) -- In the run-up to nuclear talks between the U.S. and North and South Korea, hopes are growing among investors that the meetings might not only bring peace to the peninsula but also reduce the perennial discount for Seoul’s stock market.

Fund managers from Barings to Shinyoung Asset Management say if the geopolitical risks are resolved, South Korean equities could start closing their valuation gap with regional peers. The benchmark Kospi has risen about 3 percent since March 8, when President Donald Trump first agreed to talks with Kim Jong-un, compared with a 1 percent rise in the MSCI Asia Pacific Index.

The military threat from Pyongyang has been seen as a factor weighing down the country’s stocks, heightening the so-called “Korea Discount” that stemmed from concerns about corporate governance. Despite the strong earnings from South Korean companies that drove the Kospi to a record high in 2017, the gap between the price-to-book ratios of Korean and global equities has widened to the biggest in over a decade, according to Bloomberg data.

“The Korean market has historically suffered a discount due to perceived poor corporate governance but also political risk,” said William Palmer, co-head of emerging market equities at Baring Asset Management. There’s the possibility for valuations to rise if political risk falls, he added.

The Kospi could surge if North Korea gives up its nuclear weapons, as Korean equities trade at a discount of about 30 percent compared with peers in Asia, according to Huh Nam Kwon, chief executive officer at Shinyoung Asset Management. In the short term, market sentiment may change with the talks, and it could be an opportunity “to build up stocks with good valuations and good business models,” said Yoojeong Oh, a Singapore-based fund manager at Aberdeen Asset.

Still, investors may need a little help from the chaebols. The core of South Korea’s valuation gap stems from issues surrounding the country’s conglomerates, according to June Chua, portfolio manager at Harvest Global Investments in Hong Kong.

“The Korea discount is not, for me, so much with politics,” she said. “It’s more to do with the chaebol -- that they don’t pay enough dividends and with their corporate governance issues -- rather than having North Korea as your neighbor.”

The South Korean government has recognized these issues and are pushing the chaebols to change. For example, the country’s biggest pension fund the National Pension Service is preparing to adopt new stewardship codes. It recently opposed the appointment of board members for Samsung C&T Corp, the de-facto holding company for Samsung Group, who approved the controversial merger between Samsung C&T and Cheil Industries.

Of course any form of progress from the proposed summit can only help boost investor sentiment toward the market. The two Koreas, which are technically still at war, are also expected to discuss declaring a formal end to those hostilities or even sign a peace treaty.

For Chua at Harvest, that would just be a bonus. Her focus remains firmly on the stocks themselves.

"As long as companies show earnings growth in Korea, I am happy to hold onto them, regardless of what happen to politics," she said.

To contact the reporter on this story: Heejin Kim in Seoul at hkim579@bloomberg.net.

To contact the editors responsible for this story: Divya Balji at dbalji1@bloomberg.net, Cormac Mullen, Teo Chian Wei

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