Investing in international markets is not a new theme. In addition to the lucrative returns associated with this strategy, investors often place importance on the diversification benefits of expanding their portfolios to include global securities.
For a couple of decades, China has been the main international market for American investors, which does not come as a surprise considering the stellar rate at which this East Asian country grew in this period. India is currently emerging as another high-growth region, but many institutional investors have recently shown an interest in South Korea, especially the tech sector.
Fund managers are bullish
According to data from Bloomberg, Barings Asia Growth Fund has beaten 97% of its peers in the last 12 months, which makes this fund one of the top funds in the world right now. Soohai Lim, a fund manager who is involved in the decision-making process of the Barings Asia Growth Fund, believes South Korean tech stocks are mispriced. In an interview with Bloomberg, Lim said:
"Korea is definitely interesting. We continue to find a lot of interesting ideas in the technology space. South Korea's leading tech shares, including certain memory firms, have structural growth that has been underpriced. The cyclicality of the sector is also a nice attribute amid the recent shift of investors toward shares that are more sensitive to the economy."
Nomura Holdings equity strategist Chetan Seth is also bullish on this region. In an interview with CNBC in November, he highlighted that a renewed interest in the equity markets by retail investors in South Korea is one of the main reasons behind the recent uptrend in the market and said:
"There's a reason why that is happening. Interest rates are low, property market outlook is not so great so that money, that savings, that current account surplus has to go eventually into financial assets. Equity is possibly the only avenue."
As illustrated below, this positive stance by top fund managers has led to massive foreign inflows to South Korean equities in the fourth quarter, following billions of dollars in outflows earlier this year.
Source: Bloomberg
The Korea Composite Stock Price Index, or KOSPI, is the most popular benchmark that is used to measure the performance of equities in South Korea, and the index is up over 27% this year in comparison to the 12% gain of the S&P 500 index. The initial success of Korea in curbing the spread of the novel Coronavirus had a lot to do with these positive returns, but there's reason to believe that fundamentals will support the rally in the coming year. Discussing the prospects of this region with Bloomberg, Invesco global markets strategist David Chao said:
"I continue to be constructive on the Korean economy and more so on tech stocks. The industry is bolstered by strong exports driven by an investment upcycle that's only starting to take off. After a challenging year, the semiconductor industry is finally starting to shine."
The approval of professional investors is always a good sign, as it would create more institutional demand for this asset class, resulting in higher stock prices.
The prospects
The trade war between the United States and China has given an opportunity for tech companies domiciled in many other Asian countries to secure long-term contracts with U.S. business giants, and this is one of the reasons behind the optimism for South Korea. On the other hand, the disruption of global supply chain operations resulting from the closure of borders has created a good platform for alternative markets such as South Korea, Taiwan and Brazil to negotiate new deals. In the long run, these developments are likely to help many Korean companies.
The tech-heavy nature of the KOSPI index is another driver of value as business conditions for the largest players representing the index have improved thanks to low interest rates and the fiscal stimulus packages. Semiconductor companies such as Samsung Electronics Co. Ltd. (SSNLF) and SK Hynix have high weights in the KOSPI, and the prospects for this sector are promising, considering the expected growth of the adoption of 5G technology.
The strengthening Korean won makes another case for investing in this region. Contrarian investors looking to exploit foreign exchange gains are pumping money into Korean equity markets, and there is robust demand for stocks that were previously not considered by foreign investors. Retail investors who are early to invest in Korean stocks will benefit as the index soars to new highs fueled by the demand coming from currency arbitrageurs. NH Investment & Securities analyst Kwon Ah-min believes this trend will continue. In a research note, he wrote:
"If we take the fiscal deficit keynote after the U.S. Presidential election into account, along with additional economic support policies and the collective recovery of the global economy, the trend of weakness in the dollar is very likely to continue. The won will remain strong next year based on the strength of the yuan and a recovery in exports."
Based on all these developments and the expected recovery of the Korean economy in 2021 which is expected to outpace that of the United States, it's reasonable to conclude that investors will benefit by diversifying their portfolios into this region.
The best way to gain exposure to South Korea
Even though investing in equity securities of South Korean companies is an option, an individual investor would have to carefully pick and choose which companies to invest in, which would be both time consuming and less effective for foreigners who are unfamiliar with the market. The best approach, in my view, is to invest in an exchange-traded fund that focuses on this region. Below are two of the most popular funds loved by institutional investors because of the diversification benefits and cost-efficiency:
These funds are professionally managed by BlackRock, Inc. (BLK, Financial) and Franklin Resources, Inc. (BEN, Financial), respectively.
Takeaway
To generate alpha returns, investors need to continuously sift the market to find mispriced bets. This, however, is easier said than done given the overvalued nature of global markets. Not every country will recover from the global recession at the same pace, and this disparity will drive stock market returns in the coming years. South Korea seems to be on the correct track, and exports are finally picking up along with the stimulus packages introduced by the government. The KOSPI index has easily beaten the S&P 500 this year, and this outperformance is likely to continue in the next year as well. For this reason, investing in Korean companies through ETFs seems to be the correct contrarian choice, in my view.
Disclosure: The author does not own any stocks mentioned in this article.
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