Will Hayes, Associate Portfolio Manager for Emerging Markets Equities, looks at how the South Korean equity market has been undergoing a revival.
Key takeaways:
An equity market renaissance: South Korea – the “developed emerging market” that remains hard to bucket, long viewed with skepticism by many investors and a serial underperformer – has enjoyed 12 months that have taken many by surprise.
Ongoing top-down tailwinds: the country has high exposure to the AI theme, notably through its globally leading memory manufacturers, while as an industrial hub, it has benefitted from geopolitical uncertainty through its shipbuilding, defence and power sectors.
Cautious optimism is key: corporate governance and shareholder reforms are underway, but not all companies may fully embrace a more shareholder-friendly direction.
The AI explosion is driving growth
An export-oriented economy and industrial stalwart, in the current global climate, the world is in need of what South Korea is selling. Power, shipbuilding and defence industries are booming, all sectors where products are deemed sufficiently critical to be rendered almost impossible to source from any country about which one harbours geopolitical doubts. This holds true from a North American perspective, at least.
The primary export in demand, however, continues to be memory chips. The memory sector is where AI-related bottlenecks remain most keenly felt, with prices continuing to increase across both high bandwidth and commodity memory products as demand for AI-related memory constrains capacity and supply across the board. South Korea houses two memory giants in an increasingly consolidated industry. Combined, the two companies comprise over half of MSCI Korea, and their fortunes, and the destination of AI more broadly, clearly remain vital to South Korean market performance. Optimism is high, and operational performance will need to continue to follow suit.
Raising corporate governance standards
Where attention continues to wax and wane, however, is the significant market reform that is underway. In a country where household wealth has historically been tied up in property, sizeable efforts are being made to transfer wealth to equity markets. Retail equity owner numbers have tripled in the last five years, and current president Lee Jae Myung, empowered by National Assembly backing and urged on by a mandate won based on bolstering the stock market, has been able to implement concrete measures after a period of prolonged political stalemate.
The impact of these changes should not be underestimated. Key among these is the amendment to the country’s Commercial Act to ensure that board directors have a responsibility to shareholders, not just the company. Those unfamiliar with Korea would be forgiven for assuming this was already a given. It is a move that introduces genuine accountability and consequences for those responsible for oversight. The fact that it took until 2025 for this to happen is a question for another forum, but this is just one of a raft of measures slated that can change the picture for minority shareholders in South Korea. Mandatory treasury share cancellations, cumulative voting and audit committee-related voting caps are not headline grabbers like AI and geopolitics. For investors in South Korea, however, they are similarly likely to have long-term ramifications.
A double-edged sword
The impact of the last twelve months on the South Korean stock market, attracting the country’s retail investors and them feeling the benefits of its strong performance, has been sizeable. Attracting more domestic capital overall to the Korean stock market has undoubted benefits. It is, however, a double-edged sword, particularly in a rapidly changing global environment like this. Stock price volatility in Korea continues to increase, particularly in growthy sectors popular with the retail community, and market moves have been testament to increasingly kneejerk and short-term reactions.
From a government perspective, transferring wealth into the equity market is crucial for a plethora of reasons, including supporting pensions for the burgeoning elderly population. Increased wealth may also help young Koreans feel that having a family is more affordable. Korea’s demographic issues make the country a hotbed for the development of robotics and AI, and the technological edge that comes from excelling in these areas by necessity creates a competitive edge for the country. That said, the government will no doubt want to continue to tackle the birth rate problem, and a wealth effect through Korean equities would help.
Narrowing the Korea discount
Our first conclusion is that a genuine trajectory has been set in South Korea for market reform, which is now being cemented by legislation and difficult to reverse. The checkered corporate governance history that has underpinned the “Korea discount” cannot, however, simply be erased. It would be naïve to assume that all Korean corporates, including every chaebol, have now had a change of heart and mindset in terms of how they treat minority shareholders versus their own interests.
This brings us to our second conclusion. As the government and legislators continue to set up the framework for market change, it is increasingly over to the companies themselves to act. Thus far, we have seen a rising tide lift most boats. In some cases, this has been as simple as expectations that companies with poor corporate governance track records will not be able to act quite as egregiously going forward.
We think there are limits to the durability of this type of move, and that the next couple of years will allow companies to truly distinguish themselves in terms of how they treat their minority shareholders. The onus is on companies to act, and follow the positive examples set in areas such as the Korean banking sector. Loopholes, delaying tactics and legal challenge will likely remain options. As such, whether Korean corporates distinguish themselves positively or negatively will remain up to them. We think that, regrettably, it is likely we will see both.
Market reform in motion
Finally, after a spell in the doldrums, South Korean equities are increasingly internationally and domestically relevant. Noise about the potential for the country to be upgraded to MSCI DM status has swelled.
Our view is that for now, this remains unlikely. FX and market access-related issues remain, and while measures such as the imposition of short selling bans and performance-related trading limits remain possible, we believe that the chances of an upgrade in the near term are remote.
While the government may view an upgrade to DM status as prestigious, benefits for the market and stocks, beyond a handful of companies large enough to stand out on the global stage, remain questionable. In a country that is less than 18 months on from a declaration of martial law, perhaps the relative stability that staying in EM would bring is no bad thing.