An interview with Mr Kosdaq

Since its inception in March 2000, the Atlantis Kosdaq Fund, which its manager claims is the world’s only offshore fund dedicated to investing in Korea’s second board, Kosdaq, is down nearly 42%. So why is Peter Irving, CEO at Atlantis Investment Management, smiling?

Korea is hot, not so much because it’s a fad (although some may argue that) but because it has restructured and its economy emerged from the cauldron of the Asian financial crisis stronger than ever. This is reflected in the six-month returns on the Atlantis fund, which has posted a 37% gain. Irving believes the Korea story is sustainable.

Based in London, he was the Korea portfolio manager for Schroders in the mid-1980s, when Schroders and Scudder were the only two foreign houses with Korea funds. In 1995 he set up his own Asia-focused boutique. He recently met FinanceAsia at the Mandarin Hotel’s Chinnery Bar in Hong Kong for a chat about investing in North Asia.

FinanceAsia: Some say the recent move by Samsung Electronics to repeal an amendment promising investors their preference shares will convert to common shares is typical backsliding.

Peter Irving: I don’t see it that way. What happened was that in March of 1997, Samsung Electronics made an amendment to its articles of association promising that any preference shares issued after that date would be converted to common shares. But they never issued new preference shares, and so at this year’s shareholders meeting they decided to abolish the amendment. This led a number of foreign investors to object because they thought they were being deprived of their rights. But the company has a point in saying these investors were never entitled to ordinary shares. A careful reading of the amendment makes it clear, in my mind, that it only applied to preferred shares issued after March, 1997 – but some foreign investors had been buying pre-1997 pref shares in anticipation of their converting.

Actually what this issue shows is how strong the foreign investment lobby is now. Here you have a company where more than 60% of its shares is owned by foreigners. Collectively they have the power to force management changes. But if they’re going to fight Samsung Electronics, they should do so from a position of strength, and that wasn’t the case with the preferred shares issue. But the point is that foreigners can exert influence over Korean companies. And that is a sea change.

Is there similar change regarding Kosdaq-listed companies?

The Kosdaq market has come of age. You now have companies that have real earnings, and there are some heavyweights such as Kookmin Credit Cards and KT Freetel. The exchange has tightened its listing requirements, which has meant fewer companies but of greater quality.

Yours is, you say, the only foreign Kosdaq fund.

Yes, it was launched two years ago. Today the Kospi [the main board] is at the same level as when we launched our Kosdaq fund, but the Kosdaq is 68% lower. The market was overvalued but it has changed – unlike Nasdaq in the US, which was also overvalued but has not changed. That’s what fascinates me: the Kosdaq hasn’t returned to levels seen two years ago but it can easily rise another 50% from where it is today just on the back of earnings growth. There is going to be a lot of action between now and the World Cup [in June]. The World Cup will be a focal point for foreign investors looking at Korea.

Why does a big sporting event have anything more than symbolic power?

It gives everybody an excuse to go to Seoul. Investor conferences are being arranged, and a lot of foreign fund managers will be travelling there and meeting companies. I think the Kospi market will easily reach 1,000 – and will probably contract in July and August. But fundamentally it is OK, this contraction will just be a short-term move.

There is a re-rating of Korea going on. The government has pushed reform, gearing has improved and companies are providing a high rate of return relative to other markets in Asia. The domestic economy is strong.

That’s based on consumption. Is the Korean consumer here to stay?

Yes. Historically the problem in Korea has been misallocating capital. Banks were forced to lend to chaebols while SMEs [small- and medium-sized enterprizes] starved. Even when banks reversed this after the crisis, they only lent to the strongest SMEs – the ones that didn’t need it. Now there is a fundamental shift to consumer lending. Your elderly are still high savers but the kids are maxing out their credit cards and are in debt. Ironically you have the same problem on the consumer side as you did on the corporate side – a misallocation of capital. But banks are tightening consumer loans and credit cards, and that will take the froth out of consumer spending.

Now, this is similar to the consumer debt problems in the US. But unlike the US, Korea has a current account surplus, high foreign exchange reserves and still retains high net savings. America will be OK as long as it retains a strong dollar, which encourages the rest of the world to lend and pay for this consumption. But should it weaken....

What has to happen in Korea to sustain Kospi over 1,000? Traditionally it boomerangs between 400 or so and 1,000.

There must be domestic liquidity in the market. Korea has W47-50 trillion in bank deposits and another W11 trillion sitting with brokers waiting to enter the market. But deposit rates are now 3.5%, when they used to be 12%. And Korea will develop a private pension industry like 401(k). So it is inevitable that some of that money will go into equities. Plus if MSCI decides to categorize Korea as a ‘developed’ market, which I think is likely in the next two or three years, that will force a lot of big foreign institutions to enter the market.

We could be mentioning the same things about Japan – low deposit rates, corporate restructuring, pension reform – so why aren’t investors keen?

I can tell you in one word: demographics. The Japanese are too old. They started these reforms too late. They should have begun changing things 20 years ago.

But you continue to invest in Japan.

Oh, there are still companies that are good value. But it is a very stock-dependent process. Unlike Korea you can’t bet on a market rise. But restructuring in Japan can’t be effective because the political system is not leading change. There is no desire or impetus for change. I think Japan has been marginalized and China will become the main driver in this region. Japan won’t collapse either – it will keep on patching things up. But it really doesn’t matter anymore. What’s happening in China today is much more important.

This year we are going to launch a China fund. Initially it will only cover H and B shares, and red chips, but it will invest in A shares as and when permitted. The A-share market is going to be extremely volatile but it will offer substantial returns over the next few years.

When do you anticipate foreign investors will be allowed to invest in A shares?

Sooner than people think. The government wants to spread the appeal of A shares in order to unravel its own holdings and to help finance pensions.

What are your plans then for China?

We’d like to set up a presence in Shanghai. We’re looking for a fund manager, and what we put in place there depends on whom we eventually hire.

Are you considering onshore tie-ups?

It’s a possibility. If you want a local presence you usually need a local partner. But if we’re just investing foreign money it may not be necessary. Joint ventures anywhere tend to be fraught with difficulties. It is a rare case when they actually work. The people who will make money from China are the Chinese and the foreigners will only get some crumbs – but those crumbs can be worth it.

Where does Hong Kong fit into this?

I think the financial community will soon shift to Shanghai. This is just a personal opinion, I don’t have research to back it up, but I get the sense that Beijing is a bit irritated with Hong Kong – I mean with the whole history of Hong Kong. It must be quite galling to have this success story on your own territory run by a country half way around the world, and to have to take this for 150 years. I think Beijing will be quite happy to allow Hong Kong to fade into obscurity. Hong Kong is not important to China, it is really only important to foreigners, and at the end of the day, foreigners will go to wherever there is money to be made.