TCS Daily


I'm a Seoul Man

By James K. Glassman - April 16, 2002 12:00 AM

Fresh from my very first trip to Asia, I'm asked what impressed me most. Next to the toro sushi at the Tsukiji fish market in Tokyo and the giant Buddha at the Todai-ji temple in Nara, the answer is simple: the surprisingly robust economy of South Korea. What a comeback! Call me a Seoul man. I'm sold on Korean stocks.

Unfortunately, when I started checking the numbers on financial Web sites after I got back last week, I found that I wasn't the only person to figure out that Korea was an enticing place to invest. Last year, while I was paying attention to U.S. energy shares and European conglomerates, the Korean Composite Stock Price Index, which goes by the acronym Kospi (Koreans, despite their formality, have a weakness for the cutesy pie), was rising 37.5 percent, the best in the world for an industrialized country.

And of all the thousands of mutual funds tracked by Lipper, No. 1 for the 12 months ended March 31 turned out to be Matthews Korea, with a return of 109.5 percent. In fact, four of the top 20 funds over the past year specialize in South Korean shares -- the others are Fidelity Advisor Korea, Korean Investment Fund and iShares MSCI South Korea Index. Each was up by at least 70 percent in a period when the benchmark Standard & Poor's 500-stock index returned less than 1 percent.

So, is it too late to buy Korea? Kevin Moore, who manages the USAA Emerging Markets Fund, doesn't think so. Korean stocks represent about one-fifth of his fund's assets -- the largest share, by far, for any country -- and Moore's biggest single holding is Korea's top business, Samsung Electronics Co., a diversified corporation that is widely admired. "We're quite positive," Moore says. "Korea is still considerably cheaper than the United States and Europe."

The average Korean stock carries a price-to-earnings ratio of a mere 12, or less than half the P/E of the S&P index, and profits this year are forecast to rise 57 percent.

The change in Korea since its severe financial crisis, just five years ago, is astounding. In 1997, a bubble economy -- puffed up on short-term loans from foreign banks -- suddenly collapsed in a heap. In 1998, GDP fell 6.7 percent and unemployment and inflation soared. The immediate cause was a contagious currency crisis that started in Thailand and spread to Malaysia, Indonesia and other developing Asian countries. But behind the failures were terrible business practices -- arrogant managers insulated from shareholders, with bureaucrats dictating where capital should flow, and money-losing firms propped up by politicians.

"We all know what we should have known even in the boom years: that there was a dark underside to 'Asian Values,' that the success of too many Asian businessmen depended less on what they knew than on whom they knew," wrote Choong Young Ahn, a Korean scholar, in a recent issue of the Journal of Asian Economics. "Crony capitalism meant, in particular, that dubious investments -- unneeded office blocks outside Bangkok, ego-driven diversification by Korean chaebols -- were cheerfully funded by local banks, as long as the borrower had the right government connections."

The Koreans immediately got to work. They cut their short-term external debt nearly in half, paid off a $20 billion loan from the International Monetary Fund early, boosted foreign reserves from $9 billion to $105 billion, closed nearly half the country's commercial banks and opened the remainder to foreign management and ownership, booted "zombie companies" off the stock exchanges, privatized many state-owned enterprises, cut the number of government regulations from 14,000 in 1997 to 7,000 in 2001 and improved corporate governance, forcing companies to adopt better auditing standards and more transparency.

As a result, investors rediscovered Korea. Daily average trading volume on the stock exchange went from 27 million shares in 1996 to 473 million in 2001 even though the number of listed companies dropped by 259. While my colleague Kevin Hassett and I were in the country in late March on a lecture tour sponsored by the U.S. State Department, the big news was that Moody's Investors Service raised Korea's credit rating by two notches -- a big vote of confidence.

Consider the progress of the Korea Fund, one of the best choices if you want to put Korea in your portfolio -- since so few Korean stocks trade on U.S. exchanges. Under the symbol KF on the New York Stock Exchange, it's a substantial ($900 million) closed-end fund dominated by the large companies. In a column in The Post on Nov. 12, 1998, I suggested the Korea Fund as a way to capitalize on an incipient Asian recovery. Since then, the fund has returned an annual average of 29 percent. It still appears attractive, trading at a significant discount to the actual market value of stocks it owns, including Kookmin Bank, whose largest private shareholder is Goldman Sachs Group Inc.; SK Telecom, an ideal choice in what is probably the world's most tuned-in country, where practically everyone walks around with a sleek cell phone with a color screen attached; and Pohang Iron & Steel (affectionately called Posco), which Forbes last week termed "the world's best steel company" and which, along with SK Telecom, is one of the few Korean companies offering American Depositary Receipts (ADRs). The symbols are PKX and SKM.

One big change in the Korean economy, says Mark Bickford-Smith, a co-manager of the T. Rowe Price Emerging Market Stock fund, is that it has become more balanced, with a newly robust consumer side, as well as traditional export industries (such as steel and electronics) contributing to growth.

"Credit cards did not exist in Korea until five years ago," he points out, and beneficiaries are companies such as retail-oriented Kookmin; LG Home Shopping, a holding of Matthews Korea; and Cheil Communications, an advertising firm that's a stalwart in the portfolio of the Korea Equity Fund (KEF), a smaller closed-end.

A strong consumer base means that the Korean economy is not so badly damaged when spending in markets such as the United States and Europe slows down. As a result, Korea has lately been growing at a steady rate of around 4 percent, rather than swinging wildly between boom and bust.

But the most important improvement -- reflected in interviews with economists, stock-exchange officials, money managers and business leaders -- is a new capital discipline. In the past, companies plowed all the cash they had (and then some) into building bigger corporate monuments. "Korean management went hell-for-leather investing," said Bickford-Smith. "Companies wanted to increase their market share. They didn't worry about returns for their investors."

That attitude has changed abruptly. Managers now focus on the most efficient uses of the assets that their shareholders provide them.

The job isn't finished. Labor flexibility remains a big problem. When we were in Seoul, thousands of workers were on strike protesting a plan to privatize electric utilities. It's hard to blame them, since the government provides only the flimsiest social safety net for people who lose their jobs. In addition, the chaebols -- Korea's version of Japan's notorious keiretsu, those interlocked conglomerates -- remain powerful, impenetrable and often wasteful.

But consumer prices have leveled off, unemployment is below 4 percent, and prospects for political stability seem good. Yes, North Korea -- with its black-box brand of communism -- is starving just 30 miles from Seoul (easy artillery range). But reunification as a liberal, capital state seems inevitable, and Korea, with about 50 million people in the South and 25 million in the North, will have a population nearly as great as a single Germany's and considerably greater than that of France or Britain.

But unlike those European countries, Korea is still in just the early stages of growth. That makes it both riskier and more inviting to investors. Korea is not the only emerging market to improve. While Korea (at 23 percent of assets) is the top country in Bickford-Smith's fund, the fund also owns healthy doses of stocks based in Taiwan, Mexico and India. The Price fund rose 11 percent in the first quarter of this year while the USAA emerging-markets fund jumped 15 percent. Overall, emerging-markets funds have returned an annual average of 6.6 percent over the past three years, compared with 3.2 percent for U.S. diversified-stock funds and a 2.5 percent decline for European funds. Legg Mason's emerging-markets fund, with 21 percent of its holdings in Korean stocks, has averaged double-digit returns over the past three years, and Fidelity's Southeast Asia fund, with the bulk of its assets in Korea and Hong Kong, has returned an average of 12.5 percent.

The case for emerging-markets stocks is better than ever. Valuations, says Moore, "are extremely attractive," corporate governance is improving and, after all, these countries are the fast-growing part of the world, expected to grow about three times as fast as developed nations this year.

But back to the Korean question: Are you too late? Probably not. Korean stocks such as Samsung Electronics, Korea Telecom and Posco have fallen significantly in the past month, mainly because economic growth is leading to higher interest rates. On Thursday alone, the Kospi tumbled 3.7 percent -- the equivalent of a drop of nearly 400 points on the Dow. No, you haven't missed the boat, but, in an emerging market, you can never expect a smooth cruise.

This article first appeared in the Washington Post.
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