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Petra Capital Management 1Q17 Letter – Korean Market Commentary

Petra Capital Management 1Q17 Letter, May 12, 2017

Performance/Review:

  • Petra Korean Value Equity Strategy up 4.0%, net of fees vs. Kospi Index up 6.6%
  • Strong return on Kospi driven by exceptional performance of large caps, especially, Samsung Electronics, which now comprises more than 20% of the index

Market Commentary

  • Market performed surprisingly well in the first quarter against a backdrop of much uncertainty surrounding the political crisis in Korea that began late last year
  • Ironically, political scandal that led to the impeachment of President Park Geun-hye might have provided a catalyst to pave the way for broad reform in Korea that international investors have been eagerly waiting for
  • Newly elected administration of Moon Jae-in likely to push hard for laws to strengthen corporate governance and impose stricter rules on chaebols
  • Expect to see some overhauls at NPS – as Korea’s largest equity investor with a net exposure of nearly $100B in Korean stock market, NPS’ stance as a minority shareholder in the Korean equity market is probably the most determining factor for improving the capital allocation policy of Korean public companies
  • Such progress in corporate governance is likely to reduce “Korea discount” which in turn will lead to higher valuation multiples of Korean public companies
  • Always better to invest in a market with some room to improve – on that point, when Benjamin Graham first established the concept of value investing in 1930s, US companies were not particularly known for good corporate governance
    • Idea of operating a company for the purpose of maximizing shareholder value was entirely an “alien” concept
    • Many great value investors had built their stellar investment track records for many years when most US companies were hardly shareholder-friendly
    • We expect Korea to go through a similar process in terms of corporate governance and many value investors will probably achieve outstanding investment records even before the practice of proper corporate governance gets well established in Korea
  • If you had relied on the recent Western media headlines on North Korea, you might have concluded that a war was imminent
    • In consideration of the “real” motives of the involved parties based on understanding of the modern history of Korea as well as geopolitical issues surrounding the Korean peninsula, we think that a military crisis is a very low probability event
  • Although Trump administration has recently hinted the possibility of a pre-emptive strike, it fully recognizes that taking such an action is likely to lead to catastrophic risks of regional or even global military conflicts
    • Seoul, including its satellite cities, has a population of about 20 million people and is only few miles away from the northern border
    • South Korea has about 30,000 American soldiers stationed in Korea and over 200,000 citizens residing in Korea
    • Nevertheless, a prolonged conflict in the Korean peninsula is likely to have a serious negative impact on Korean economy amid the escalating rivalry between the US and China
  • In response to Korea’s decision to deploy an American anti-missile system, Terminal High Altitude Area Defense (THAAD), designed to shoot down North Korean missiles, the Chinese government has retaliated against South Korea by issuing consumer boycotts of South Korean products and entertainment services, claiming that THAAD’s real intention is to allow the US to monitor China’s own military defenses
  • Good news is that China’s policy towards North Korea is likely to change at least out of its own interests
    • China wants North Korea to abandon the nuclear program because it does not want to see a regional arms race that may lead Japan and South Korea to build their own nuclear weapons
    • Although China and North Korea are officially still allies, made it clear that it is furious about North Korea’s recent belligerence
    • Even voted in favor of US-led sanctions against North Korea
  • After several years of lackluster performance, the Korean stock market has become an attractive market for value hunters
Image Source: KOTRA, Linkedin
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