By Raheel Altaf, co-manager of the Artemis Global Emerging Markets Equity fund
One of the big stories in Asia in recent months has been a sizeable shift in investor sentiment towards Japan. Landmark governance and stewardship reforms have enhanced the appeal of a market that spent many years out of favour.
Less appreciated is that something similar is now happening elsewhere in the region. Thanks to South Korea and China, an approach that is already succeeding in a developed economy is being applied in an emerging market setting.
It is first useful to remind ourselves why the trail blazed in Tokyo also makes sense in Seoul and Beijing. Simply put, many businesses in all three of these countries have long failed to use capital efficiently.
Historically, Japanese companies’ tendency to hold too much cash while returning insufficient profits to shareholders has been especially well known. It has inevitably dampened investors’ enthusiasm.
Last year, determined to at last tackle the problem, the Tokyo Stock Exchange (TSE) announced firms trading at a price-to-book ratio of less than one would need to “comply and explain”. They would also have to show evidence of engaging with investors in attempting to improve.
The TSE reasoned some businesses would willingly embrace change and others would dutifully follow suit. It was right on both counts. Yet this healthy response to peer pressure has spread beyond Japan’s borders, with potentially significant implications for investment decisions.
South Korea
The driving force behind efforts to make South Korean businesses more attractive is the Corporate Value-up Program. Launched earlier this year, it aims to deliver what the country’s Financial Services Commission (FSC) has described as “fundamental changes in our capital markets”.
The proposed way forward is conspicuously similar to Japan’s, with FSC chairman Kim Joo-hyun specifically championing “practices that place a priority on shareholder value”. Companies are being encouraged to reduce cash balances, raise dividends, buy back shares and implement more shareholder-friendly policies.
In addition, also as in Japan, they are being urged to move away from cross-shareholding. This controversial practice, which involves firms holding shares in their business partners, has long been underpinned by ownership models dominated by wealthy South Korean families with little or no appetite for disrupting the status quo.
See also: Japan: What’s next?
As the process of transformation gathers momentum, many promising stocks remain notably undervalued. Kia Motors, part of the Hyundai group, offers an illustration.
Kia is carving out a sizeable presence in the electric vehicle (EV) arena. It sold more than three million units in 2023, and its EV9 was named World Car of the Year at this year’s New York International Motor Show. Yet it is trading at a price/earnings (P/E) ratio of just 6x at the time of writing.
Banks and insurers also merit attention. Companies such as JB Financial, Hana Financial and DB Insurance are benefiting from a wider recovery that is largely fuelled by South Korea’s semiconductor exports.
China
The Chinese government has issued just three sets of capital market guidelines during the past two decades. The latest, unveiled in April this year, clearly echoes Japan’s reforms.
China’s State Council has called for the creation of a “secure, regulated, transparent, open, dynamic and resilient capital market” that can “serve the goal of advancing Chinese modernisation”. The “highest standards” for listed companies have been identified as crucial to ticking all these boxes.
The effects of more stringent regulation are already apparent. Several businesses have announced share buyback plans after being warned they could be delisted for trading at low levels, while others have declared they will pay dividends for the first time.
It is true, of course, that China still faces geopolitical headwinds. Nonetheless, the CSI 300 Index – which replicates the performance of the top 300 companies on the Shanghai and Shenzhen Stock Exchanges – has enjoyed a healthy rebound from February’s five year-low.
See also: Will ‘value up’ governance reforms address the ‘Korea discount’?
COSCO is a good example of the low-valued, high-yielding stocks that should be worth seeking out against this backdrop. Already established as China’s leading shipping company, it is currently positioning itself for a green future by investing in carbon-neutral vessels.
The case of Sinotrans is perhaps even more striking. Despite being one of the country’s major providers of freight-forwarding services, the business is trading at a P/E ratio of only 6x at the time of writing – having slumped to below 3x at the end of 2022.
Positive change and long-term opportunity
To witness the impacts of measures like these in a developed market (DM) such as Japan is interesting enough. To witness them in emerging markets (EMs) such as South Korea and China is arguably even more fascinating.
Investors might reasonably wonder whether Japan represents an inherently less risky choice. After all, EMs are usually regarded as more volatile than their DM counterparts.
Increasingly, though, there is often little between the two. South Korea narrowly missed out on DM categorisation only weeks ago, while many DMs believe a country like China – the world’s second-largest economy, lest we forget – has no right to be classified as an EM.
Ultimately, the DM-versus-EM debate involves multiple perspectives, nuances, claims and counter-claims. This explains why it has raged for years. The finer details may be important to investors, but they constitute another story for another day.
What really matters here and now is that markets such as South Korea and China are fully recognising the value of reform. They are actively pursuing – and already achieving – positive change.
This is likely to give rise to a growing number of long-term opportunities. Forward-looking investors who appreciate the power of diversification may wish to take note and broaden their horizons accordingly.
See also: Will frontier markets benefit from deglobalisation?
