• Korean equities have low multiples even compared to other emerging markets.
• The US dollar has likely peaked and will support emerging markets as it weakens further.
• Korea is looking to enact tax policies that specifically seek to improve shareholder returns.

Investment thesis

The iShares MSCI South Korea ETF (NYSEARCA:EWY) offers exposure to large and mid-cap Korean equities; the underlying index covers approximately 85% of the total Korean market cap.

Korean equities have done poorly compared to other emerging markets (or EMs) in recent years:

In the past, financial market observers even coined the term "Korean discount" in reference to the perpetual undervaluation of Korean stocks. The explanations for the discount cite poor transparency in the typically family-dominated conglomerates and insufficient shareholder returns.

However, this summer the Korean government has announced, among other tax proposals, specific measures aimed at encouraging public companies to increase their dividends and buybacks. Given the macro backdrop is turning positive with a declining US dollar (DXY) while Korean multiples have much room to grow, the recent tax changes may act as a catalyst.

#1 - The macro is improving for EMs

Historically, emerging markets have been inversely linked to the US dollar:

The dollar has been strong the past couple of years as the Fed has been tightening its monetary policy. However, currently, futures price a 100% rate cut probability at the next FOMC meeting in September:

The dollar likely peaked in 2022, but still has a lot of room to "mean revert":

Fiscal policy may also bring the dollar down further. First, US government debt is growing at incredible rates, and that should at some point pressure the currency. Second, at least one of the US presidential candidates, Donald Trump, has openly talked about his preference for a weaker dollar anyway.

#2 - Korean multiples have the most to grow

While the US dollar trend should be supportive for all emerging markets, cheaper valued countries should have the most room to reprice.

Currently, Korean equities compare quite well to many other EMs on a price to earnings basis (trailing multiples sourced from Yahoo! Finance):

• Korea ETF (EWY) - 9.6x
• South Africa ETF (EZA) - 10.4x
• Indonesia ETF (EIDO) - 10.6x
• All emerging markets (EEM) - 12.2x
• India ETF (INDA) - 31.6x

In general, most emerging markets are currently cheap - compare these multiples to 28.1x for the S&P 500 (SPY), for example. But Korea is on the low end even among the EM universe.

#3 - Tax reform may be a catalyst

What initially spurred my interest was the news that the current government is seeking to enact tax policy changes that aim to bolster the stock market and enhance shareholder returns.

According to the linked Korea Herald article:

The reform also includes incentives for companies focused on value enhancement, such as a tax cut on corporate taxes equivalent to 5 percent of increased shareholder returns [i.e. buybacks], and a reduced tax rate for higher dividends received by investors with financial income exceeding 20 million won [about $15,000].

From other sources, I infer that this tax proposal still has to go through the legislative process but is backed by the Ministry of Economy and Finance. If approved, the new changes would come into effect in January 2025.

The biggest impact may be the tax credit for buybacks. Contrary to places like Canada that now tax buybacks, the Korean government would offer a tax credit for them. I understand the credit is limited to 1% of the buyback amount, but for a corporation in a taxable position, this means that the government is effectively providing the cash for this 1%.

The rule appears more complicated because it also matters if companies increase their buybacks relative to prior years, but if company that did no buybacks before now decides to buy back 5% of its market cap, it would only need to spend cash on 4% of that while the government will pick up the rest through the tax credit.

The dividend proposal could also have a positive impact. Individual shareholders in companies that have formally announced increased shareholder return policies may see their withholding tax rates reduced on dividends from these investments. Lastly, an unpopular financial investment income tax that had been previously announced would be abolished, effectively reducing capital gain taxes for many investors.

In general, it is very positive that the government is seeking to incentivize higher shareholder returns. Higher stock prices should be the natural outcome.

EWY is a reasonable vehicle to get exposure

EWY boasts over $5 billion in assets under management and ETF is fairly liquid with 0.02% mean bid-ask spread. Expenses aren't super low at 0.59% but generally country-focused ETFs don't have very low fees.

The fund has significant concentration in Samsung and Hynix:

However, apart from these top two holdings that may be too tech-heavy, the remainder looks pretty balanced.

Takeaway

Korean equities have fairly low multiples and are set to benefit from a decline in the US dollar. The ongoing tax proposals in Korea that specifically seek to enhance corporate shareholder returns may act as a catalyst for a repricing higher.