Investors Propose Remedy for Korea Discount

Group says Korean equities have ‘chronically underperformed’ for seven years.

A group of shareholders led by investment management firm Dalton Investments is appealing to the $578.7 billion Korea National Pension Service (NPS) and the Korean government to implement initiatives to improve the returns of the country’s equities market, which it says has “chronically underperformed” over the past seven years.  

In a letter to the NPS and the National Assembly of the Republic of Korea, the investors laid out ways in which the country can turn around “one of the worst- performing and most undervalued markets in the world.”

The investors pointed out that over the past seven years, the total shareholder return of The Korea Composite Stock Price Index (KOSPI) was just 25%, despite corporate profits increasing 80% over the same period. They said the NPS, which owns approximately 7% of the Korean equities market, has suffered greatly as a result of this sustained underperformance.

“The issue, however, extends to the entire country of Korea, which is facing continuously slowing economic growth and the highest unemployment rate since 2001,” said the letter. “While Korean companies have generated a great amount of value, this value has not been effectively transferred to Korean households and the economy.”

The investors group proposed actions to help improve the so-called “Korea discount” and shareholder returns. The Korea discount refers to the undervaluing of South Korean stocks by global investors due to factors that burden the country’s economy, such as threats and nuclear and missile tests by North Korea.

They said that the underperformance in the Korean equities market is systemic, and is caused by a tendency of corporate management teams to “pursue misguided capital allocation strategies, which inevitably ignore the interests of minority shareholders.”

According to the group, Korean companies are not prioritizing return on capital, risk-adjusted returns, and basic minority shareholder interests. They recommend that all capital allocation decisions be measured against the “next best alternative,” including share repurchases and dividend payouts, with the goal of maximizing long-term economic profit for all shareholders.

“It has become all too common for Korean companies to accumulate what amounts to a treasure trove of assets, including cash that sits idle and unproductive on balance sheets,” said the letter. “Given no better alternative, Korean companies should return this capital to shareholders so that capital can be allocated to other opportunities. Instead, Korean companies hoard cash.”

This cash hoarding has resulted in significantly below-average payouts, according to the investors. They point to Taiwan as a country that is economically similar to Korea, but has an average dividend payout ratio of 58% compared to 17% for Korea. The group says that Taiwan’s total shareholder return was three times more than that of Korea for the past seven years.

The group said that if structural changes are not implemented that enable companies to achieve greater returns, the amount individuals contribute to the national pension fund will have to increase by as much as 13% in the long term, and up to 38% in the “very long term.”

The group’s recommendations include implementing better capital allocation strategies and aligning management incentives with those of all shareholders; better alignment of tax rates to encourage fairer practices, and encouraging an automatic investment system for retirement pension as the default option.

“If action is not taken now, this problem will only become more pronounced during a period of low growth, fierce competition, high unemployment, aging demographics, and greater wealth inequality,” said the letter. “As the largest shareholder of Korean equities, NPS has the power to push public companies to adopt better practices … [and] the ability to drive and lead this change.”

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