How to Invest in South Korea

03/19/2015 10:00 am EST

Focus: GLOBAL

The US stock market is rather expensive, while Europe is mired in slow growth. Japan has a massive budget deficit and China has a banking system that is deep trouble, asserts Martin Hutchinson in Daily Profit.

Yet there is one country that appears relatively untroubled and should form a central part of any risk diversification program. That country is South Korea.

South Korea has government spending of 33% of GDP. Among the OECD's 35 member states, only Chile spends less. Even more impressive, it consistently runs a modest budget surplus, so that even with relatively high defense spending, its public debt is only 37% of GDP.

With a generally free-market orientation, South Korea—a democracy—has thus avoided the extreme monetary and fiscal policies pursued by most of the world in recent years.

South Korea is one of the most energy-import-dependent world economies. This is, of course, a big benefit currently, given the recent decline of oil prices. Moreover, many of its industries—such as shipbuilding and steel making—are highly energy intensive.

If you want a direct indexed exposure to South Korea, the iShares MSCI South Korea Capped ETF (EWY) is the biggest player. It's substantial with $4 billion in assets, an expense ratio of 0.62%, and a yield of 1.2%.

Its capped nature means it avoids investing too much in the very largest conglomerates, notably Samsung, which would otherwise make it unbalanced.

If you prefer some stock picking expertise—including domestic South Korean companies you can't buy directly from the US—you might look at the Matthews Korea Fund (MAKOX). This is an open-end mutual fund which has been investing in Korea since 1995 with an excellent track record.

The fund is small, with $184 million in assets. Its expense ratio of 1.1% is acceptable for an active fund and has beaten the KOSPI share index over every period since its inception.

For direct investment in South Korean shares, I suggest you look at two stocks that should be major beneficiaries of the decline in energy costs.

The first is Korea Electric Power (KEP), the country's regulated electric utility. The stock is currently trading at 10 times trailing earnings.

It paid a small dividend in 2014 and Korean analysts expect a much larger dividend to be declared this year. The yield could rise to 3.4% in 2015 and 5% in 2016.

The stock is currently trading at 54% of book value, and has the advantage that its operating capacity utilization is steadily improving, driven by the 4% annual increase in South Korean power usage.

The second is Posco (PKX), one of the world's largest and most efficient steel companies. The shares are trading on 10 times expected 2015 earnings.

Based on dividends declared in 2014, the shares yield 3.2%, but a dividend increase can probably be anticipated. It's worth noting that Warren Buffett owns a 5% stake in the company.

Overall, South Korea is fertile ground for value investors. Whether you buy an ETF, mutual fund, or individual stock, now is a good time to buy South Korea.

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