KF: Ride The Korean Recovery At A Wider Than Usual NAV Discount

The final 12 months or so has been dismal for Korean shares; whereas the YTD rally has recovered among the losses, the Kospi index stays >30% off its 2021 highs. The elements that led to this underperformance look set to reverse, nevertheless, as we enter a (comparatively) weaker USD/impartial financial coverage regime and China returns to progress mode (vs. the sturdy USD, excessive charges, and weak China backdrop). Given the sensitivity of Korean company earnings to the commerce steadiness, equities needs to be the primary port of name for world buyers to re-rate as fears of a worldwide recession abate. And with the virtuous cycle reversing into 2023 amid a weaker greenback and an increasing China, the exporter-heavy Korea Fund (NYSE:KF) portfolio ought to lead the rebound.

From right here, all eyes will probably be on the Financial institution of Korea’s (i.e., the Korean central financial institution or the ‘BoK’) fee choice subsequent week. Given the potential macro headwinds and decelerating inflation pattern domestically, an accommodative coverage stance is probably going on the playing cards, preserving valuations well-supported. A pending inclusion into the FTSE World Authorities Bond Index (WGBI), which might entail vital passive inflows into Korean bonds, presents an extra near-term technical catalyst as effectively. At a wider than standard high-teens % NAV low cost, KF is a compelling automobile to play the Korea restoration.

Fund Overview – A Competitively Priced however Concentrated Korean Funding Car

The actively managed, US-listed Korea fund seeks to ship long-term capital appreciation relative to its benchmark MSCI Korea 25/50 Index primarily by means of investments in securities listed on the Korea Inventory Alternate. The fund is managed by JPMorgan (JPM) Korea nation specialist John Cho, who has been within the function since 2011 and works out of Hong Kong as a part of the Rising Markets and Asia Pacific Equities group. The fund leverages a high-conviction, value-focused strategy to figuring out funding alternatives, although progress and high quality are additionally elements within the fund’s inventory choice course of. Per the newest factsheet, the fund held $129m of internet property on the time of writing and charged a aggressive ~1.1% expense ratio (primarily administration charges). A abstract of key information concerning the fund is listed within the graphic under:

As highlighted by the fund’s newest holdings disclosure, KF is pretty concentrated from a sector standpoint. Info Expertise is the biggest allocation at 34.0%, adopted by Supplies at 14.8% and Client Discretionary at 11.9%. Different sectors with portfolio contributions exceeding the 5% threshold embrace Financials (11.4%) and Communication Companies (9.3%). In whole, the highest 5 sectors make up ~81% of the general fund.

The KF fund’s single-stock allocation displays the concentrated tech publicity – the biggest holdings by far are semiconductor/cell big Samsung Electronics (OTCPK:SSNLF) at 23.4% and SK Hynix (OTC:HXSCF) at 6.9%. The fund’s different main tech holding is NAVER Corp (OTCPK:NHNCF) at 3.6%. The massive Supplies publicity comes from two key holdings, LG Chemical (OTCPK:LGCLF) at 6.6% and POSCO Holdings (PKX) at 3.9%. The fund’s financials allocation, then again, is unfold throughout a wider vary of holdings, led by KB Monetary Group (KB) at 4.1%. All in all, the highest ten holdings accounted for 59.3% of the general 98-stock portfolio, with the focus ranges and portfolio composition intently monitoring its benchmark MSCI Korea 25/50 Index.

Fund Efficiency – Outpacing the Benchmark however the NAV Low cost Stays Large

On a YTD foundation, the fund has risen by 6.4% in market worth phrases, trailing passive Korea ETFs just like the iShares MSCI South Korea ETF (EWY), which has returned 11.9% this 12 months. Over longer timelines, nevertheless, the fund has modestly outperformed its key comparable EWY and its benchmark index. In NAV phrases, the fund has annualized at a strong +10.4% since inception in 1984, whereas the final decade has seen the fund compound at +3.1% vs. the EWY’s +2.1% and +2.4% for the MSCI Korea 25/50 Index. In market worth phrases, nevertheless, the fund’s outperformance fades as a result of persistent NAV low cost – the fund’s +2.2% annualized return over the past ten years is broadly consistent with the EWY and barely under its benchmark.

At first look, distributions appear sturdy at a complete yield of ~15% on a trailing foundation. However most of final 12 months’s distribution got here out of realized brief and long-term capital features, leaving the yield from recurring revenue at <1%. Final 12 months was a difficult 12 months for the tech/exporter-heavy KF portfolio, although, so 2023 revenue distributions ought to are available in a lot greater. Whereas a reversion to historic ranges would indicate a 1-2% yield, distributions are typically inconsistent; thus, this fund is not an ideal match for revenue buyers. Within the meantime, the fund trades at a wider than standard high-teens % NAV low cost (vs. low to mid-teens % common in 2021/2022), doubtless resulting from downbeat investor sentiment on the fund’s prospects. Whereas there is not a transparent catalyst for the NAV low cost to slim anytime quickly, the performance-linked buyback (as much as 25% of excellent shares) does supply some draw back safety.

Elementary and Technical Tailwinds on the Horizon

As an economic system extremely leveraged to world commerce exercise, South Korea has been compelled right into a destructive suggestions loop triggered by the sturdy USD/greater fee atmosphere abroad final 12 months. Issues are reversing this 12 months, nevertheless, as the mixture of much less hawkish coverage, a stronger received, and post-reopening Chinese language progress has already pushed a narrowing of final 12 months’s document commerce deficit (see chart under from Buying and selling Economics). In keeping with the Korean economic system’s reliance on exports, an outsized % of Korean corporates are additionally depending on commerce, so an eventual restoration in China and different rising market economies bodes effectively for the near-term earnings outlook. Within the meantime, a transitory stock glut is weighing on chip costs, although coverage assist (primarily through tax cuts) and server/synthetic intelligence demand tailwinds ought to preserve tech exports sturdy by means of H2.

Moreover, decrease FX-driven import prices have additionally led to decelerating inflationary pressures, supporting the case for a BoK pivot later this 12 months. Both approach, the elemental setup is compelling for KF’s exporter-heavy portfolio, and buyers stand to reap the advantages each methods (valuation re-rating and earnings progress). Additionally price monitoring would be the pending inclusion of Korean bonds into the FTSE Russell WGBI subsequent 12 months; considerably elevated passive inflows post-inclusion (albeit over a staggered 18–24-month interval) presents a technical tailwind for fairness valuations through decrease risk-free yields.

Conclusion

The Fed is lastly pulling again on its tightening cycle, and that bodes effectively for economies like Korea, which stay closely leveraged to commerce exercise. 2023 has already began off on the suitable foot, with the mixed impact of a weakening USD and a return to progress in China driving Korean equities greater YTD. Extremely cyclical funds like KF, which fell out of favor amid the document commerce deficit final 12 months, needs to be among the many main beneficiaries of the present atmosphere. On the present high-teens % NAV low cost, buyers stand to win each methods – through a re-rating of the fund itself and of the underlying export-focused holdings, a lot of which proceed to commerce at a reduction to their ebook worth. A extra dovish BoK subsequent week (in gentle of the exterior headwinds and fading inflationary pressures) presents an upside catalyst, together with passive inflows from an eventual WGBI inclusion for Korean bonds (doubtless early subsequent 12 months).