The ‘overlooked’ Korean stock market offers investors the chance to snap up shares in big names like car maker Hyundai at up to 50% off, and Weiss Korea Opportunities (WKOF ) is taking full advantage.

Launched nine years ago, the £150m investment trust, run by Weiss Asset Management in Boston, USA, is not just a specialist single-country fund. It also adds another layer of specialism in only investing in Korean preference shares or non-voting shares issued by around 120 companies on the country’s Kospi 200 index.

Mark Lewand, Weiss’ head of investor relations, said preference shares are ‘particularly interesting because they get the same economic benefit as voting shares plus a nominal payment, like a fixed income coupon’.

‘They are economically superior,’ he said.

Chaebol history

Preference shares began to be issued 30-to-40 years ago by large companies controlled by Korean ‘chaebols’ – or powerful families – to raise equity without diluting their own voting rights.

The lack of vote means the shares trade at an often-steep discount to the voting shares.

Jack Hsiao, a portfolio manager working on WKOF, said price plays a large part in his stock-picking criteria.

‘The first [criteria] is how cheap a particular non-voting share is relative to the voting share,’ he said. ‘There is always a price for everything; even if it is a terrible company, if you can buy a share for 1p, you do it.’

The trust, which has a current yield of 2.4%, also considers the dividend on offer, something which is moving to the forefront of Korean investors’ minds as, like Japan, government policy has encouraged the return of capital by historically conservative companies that have held high levels of cash.

‘Korea, has in the past, paid low dividends but in the last five years that has changed,’ said Hsiao.

‘The dividend is important because it provides a floor for how cheap shares can get. Plus, you can buy a 2% dividend at a 50% discount and get a 4% yield.’

While Japan is ‘three-to-five years ahead’ of Korea in terms of stewardship codes and government action, Hsiao said ‘there is a general push by the investment community to see higher pay-outs’.

‘At companies like Samsung we are seeing aggressive capital returns and that has set the bar for the rest of the market,’ he said.

Swing from Samsung

With a value of $361.5bn, Samsung Electronics is one of the biggest stocks on the Kospi but fell out of the fund’s top 10 holdings about a year ago. A rally in the shares substantially reduced their discount, prompting the managers to switch to other more undervalued shares.

As a result, the 38 positions in the portfolio now stand on an average 52% discount to their voting shares.

But while focused on price, Hsiao said ‘we are not looking to buy unviable or fraudulent companies’, so quality does come into play.

‘A lot of the holdings are multinational companies with good cashflow and good balance sheets,’ he said. ‘It is testament to the stock selection process that the portfolio of non-voting shares is not underperforming the broader market.’

Hyundai could re-rate too

The fund’s biggest holding, making up 13% of the portfolio, is a well-established name: auto giant Hyundai.

Hsiao said he was ‘very excited’ about the stock because the preference shares were trading on an ‘irrationally wide’ discount nearing 50%, offering a yield of 6% ‘which is insane for an auto company and a company that still has upside and a healthy balance sheet’.

Hsiao believes the fund is also set to benefit from a change in the law that will directly affect Hyundai and narrow the discount considerably.

In recent years the government has outlawed ‘circular companies’, where the original company invests in shares of another company that then invests in the original company. This includes Hyundai, which owns shares in Kia, that in turn owns shares in a Hyundai subsidiary that owns shares in the main Hyundai group.

‘That has been outlawed by government and Hyundai did already try and restructure,’ said Hsiao.

However, the effort was thwarted by activist investors Elliott Advisors which voted against it ‘and caused a shareholder backlash’. The company is due to come to market with a new proposal and the new restructuring should help narrow the discount.

‘We are paid a 6% yield but are invested in a company with a strong balance sheet that has invested in its electric vehicle divisions and there is an upcoming catalyst in one-to-two years of restructuring that could narrow the discount,’ said Hsiao.

Other holdings in the top include chemicals giant LG Chem, cosmetics group Amorepacific Corporation and Hanwha, a conglomerate whose interests stretch from explosives to retail and financial services.

Cheap market

A measure of the portfolio’s cheap valuation is that the shares trade on just over five times’ their last 12 months of earnings, or profits. 

‘There is a bit of underappreciation for the Korean market and when people think of it they do not think of growth or innovation, but it is always in the top five lists of most innovative countries,’ Hsiao said.

‘It has the most patents per capita and we see a lot of new growth companies, especially in electric vehicles and batteries – Korea is producing a third of electric battery supplies. Most people do not realise it but there are a lot of growth and green opportunities here.’

However, in the past year the trust has broadly tracked its benchmark, the MSCI Korea index lower. The shares have fallen 19% as fears of rising US interest, a strong dollar and more recent concerns of slowing global growth have seen overseas investors cut their weighting to South Korea. 

Well backed

Longer term the trust has outperformed the index, with total shareholder returns of 52.9% over three years and 61.8% over five years that beat the benchmark’s 19.2% and 28.5% over the same time periods.

Despite the recent setback, the trust has avoided falling to a wide discount itself, with the shares closing last week at 3% below net asset value. 

Discount hunter City of London owns nearly a quarter of the shares, its interest in buying undervalued investments making it the trust’s biggest investor. Other leading UK investors, with smaller stakes, include Edentree, Ruffer and CG Asset Management, manager of Capital Gearing Trust (CGT ).