With two Korean funds heading investment performance tables over the three years to the end of July, should the country be a must for the bolder investor?
If asked to name the best performing unit trusts and Oeics over the period from 1 January 1998 to 31 July 2001, most commentators would probably pick American funds, many of which outperformed during the technology boom, or specialist portfolios investing in areas such as pharmaceuticals. But, according to data from Standard and Poor's, the top two funds over that period in terms of returns both focus on Korea ' hardly an area known for mainstream investment opportunities.
Standing proudly at the top of the Standard and Poor's statistics, out of a total of 1427 funds with a three-year track record, is the Baring Korea Trust, closely followed by JP Morgan Fleming Korea, which changed its name from Save & Prosper Korea in May 2001.
On an offer to bid basis over the 43-month period, Baring Korea would have returned £302.14 and JP Morgan Fleming £295.84 on an initial investment of £100.
Perhaps the most immediate question when considering these funds is whether their outperformance is a result of genuine macro and microeconomic strengths in Korea or merely some kind of investment fluke.
Looking at the country's stock markets, in the three years to 31 July, the Korean Composite Index (KOSPI) returned 61.67% in local currency terms, although its performance was strongly influenced by the technology boom and has subsequently tailed off since.
After an appaling year 2000, during which Korean markets fell around 50% in the wake of the technology crash, this year has seen Korea suffering the effects of a global slowdown along with the rest of the world's major economies.
The fall-off in technology can also be seen in the performance of the Kosdaq Composite index, Korea's equivalent of the Nasdaq, which produced a return of -2.46% over three years to 31 July. In the midst of that period came the technology bubble, however, and during the year from 31 March 1999 to 31 March 2000, the Kosdaq index returned 177.32% in local currency terms.
Manager of the £55m Baring Korea Trust, Ernie Tam, says its outperformance over the past three years has been down to three main factors: timely participation in the economic recovery after the IMF crisis in 1997/8; avoiding what he calls 'the internet disaster' and favouring mid-cap stocks after the collapse of the technology bubble. He says his basic investment style is growth at a reasonable price, always looking for inflection points and themes in the market and tending to avoid momentum investing.
'Risk aversion remains high in the region,' he says, 'which is generally positive from a contrarian viewpoint. The cyclical derating of the market last year was a fair and accurate reflection of poor domestic and external growth prospects and, from a cyclical viewpoint, the downside risk is largely reflected in the market.'
At the micro level, Tam says he continues to find more stocks to buy than sell. In particular, he says there are good franchises to be found in the mid-cap industrial sectors, which he feels have always been largely ignored during the past bull markets.
Tam adds that selected technology and industrial stocks have also provided a superior risk and return profile after the significant de-rating over the past 12 months.
As for the £2.5m JP Morgan Fleming Korea fund, regional specialist for Asia and Japan at the group, Adam Matthews, attributes the portfolio's consistent outperformance to bottom-up stock selection. He says there are two Asian-based managers working on the fund, Ted Pulling and David Choy, who aim to generate performance by identifying restructuring and good earnings stories in the Korean market before their competitors.
'As a house, we tend to take large bets at stock level,' he says, 'and this fund has benefited from a handful of Korean companies performing extremely. One such example is Kookmin Bank. Korea had always been hesitant on consolidation among its banks but with the sector growing gradually weaker, the Government has now stepped in to ease the way for mergers. Kookmin is now in the process of merging with the Housing and Commercial Bank and the merged entity will be Korea's largest mortgage lender, the equivalent of a merged Halifax and Barclays in the UK.'
Matthews also points to Kookmin Credit Cards as another company set to benefit from structural change currently under way in Korea. Until recently, he says, credit card penetration had been negligible in the primarily cash-based society of Korea but now the Government is keen to find a way of auditing business expenses and feels cash transactions are too easy to manipulate.
'The Korean Government has forced all retailers to accept cards, which has obviously led to rapid credit card diffusion across the country,' he adds.
Despite the largely stock-specific nature of the outperformance of the JP Morgan Fleming and Barings funds, their consistently strong returns are all the more impressive considering Korea's volatile macroeconomic background.
Fund manager for Korea at Foreign & Colonial, Stephanie Wu, says that the Korean market has been on a downwards trend for most of this year, despite two rallies on the back of global interest rate cuts in January and May.
'With its relatively high level of gearing into foreign countries, Korea tends to benefit from global rate cuts and increased liquidity flows, as can be seen from the two rallies this year,' she says.
'However, as a major exporting country, especially of electronic goods and semiconductors, Korea is highly geared into the economic cycle of the G7 nations and, as most of these are currently experiencing economic slowdown, the Korean economy has been flat.'
Investment manager at Britannic Asset Management, Dougie Watt, says he tends to use Korea as a trading market rather than taking long-term positions in stocks, primarily because of this cyclicality in the country's economy. He gives the situation with DRAM, a type of computer memory, as an example of this.
'At the height of the technology boom, Korea's DRAM producers, such as Samsung and Hynix, were obviously performing well,' he says. 'But as this market became increasingly commoditised, the price of DRAM collapsed and these Korean companies were faced with the problem of too much supply and no demand. This highlights the essential problem with the Korean economy for me.'
Matthews says JP Morgan Fleming Korea has managed to avoid this cyclicality to an extent by underweighting technology and telecoms and taking larger bets in domestic restructuring-type stocks. However, he acknowledges Korea is a high beta market relative to the Nasdaq ' when the Nasdaq rallied 15% earlier this year, Korean markets exaggerated this by gaining 25% ' and so when global growth picks up, Korea's traditional business strengths should prove the best performing sectors.
While admitting exports have slowed and the growth picture is now looking weak, Matthews is more bullish on the state of the Korean economy than many other investors. 'Over the first six months of this year, Korea re-emerged in the global economic picture, with the economy not slowing as much as expected and domestic spending remaining strong throughout the first quarter,' he says. 'This tempted foreign investors back into the market and after a poor 2000 for Korea, with the average daily trading volume in the markets down 50% over the year, it didn't take much money coming in before the market began to look better.'
Head of global emerging markets at First State Investments, Angus Tulloch, says valuations look cheap in Korea relative to the rest of Asia but investors must bear in mind that there is a reason behind this.
'Companies in Korea have traditionally been run to maximise sales growth rather than shareholder wealth,' he says. 'Many companies are beginning to realise the importance of minority shareholders, however, and the corporate governance picture is far more attractive today than five years ago. If it continues to improve, Korea may be due a re-rating at some point down the line.'
One further potential problem for the Korean economy, according to Wu, is the spectre of inflation, primarily because of the current weakness of the Korean won.
'The won tends to follow the Japanese yen,' says Wu, 'and has therefore performed poorly this year. This weak currency has left the Bank of Korea unable to keep pace with global interest rate cuts in order to stimulate growth, although it has managed three 25 basis point cuts so far this year. Korea is also a major importer of oil and so the increase in crude oil prices has also had a negative effect on its economy.'
However, with consumer spending holding up and the Government announcing further spending on infrastructure in a recent budget, Wu says most analysts are relatively sanguine on the prospects for moderate growth in Korea this year.
'The last sustained rally in Korea began in the fourth quarter of 1998, in the midst of global monetary easing and a swing from a current account deficit to a trade surplus in the region,' she says. 'With expectations for growth among the G7 nations slowly improving, we are gradually moving towards such a scenario again.'
• There are good restructuring stories to be found in Korea.
• Inflation remains a threat in light of the weak won.
• Outperformance in Korean funds has been down to stock selection rather than a helpful macroeconomic background.
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