Top Korea Fund Says Smaller Stocks Still Spell Bigger Returns

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South Korea’s smaller companies are outperforming larger stocks by the most in at least 10 years. The nation’s best-performing equity fund is betting on further gains.

The Kospi Small Cap Index has jumped 37 percent this year, outpacing a 0.3 percent advance in the benchmark Large Cap Index and beating the MSCI Emerging Markets Small Cap Index that declined 0.9 percent. The Midas Miso Mid & Small Securities Investment Trust fund returned 61 percent in the past year, the best performance among 149 local funds tracked by Bloomberg.

“The trend will hold,” said Heo Pil Seok, Seoul-based chief executive officer of Midas International Asset Management Ltd. “The traditional smokestack industries have no growth prospects. Smaller companies in sectors of cosmetics, tourism and biotechnology are booming with nimble strategies tailor-made to meet Chinese demand and fit an aging society.”

South Korea’s small-cap companies have made a leap forward against the backdrop of President Park Geun Hye’s push to level the playing field with conglomerates. Family-run companies from Samsung Electronics Co. to Hyundai Motor Co. reported second-quarter profit missed estimates. Growth in Asia’s fourth-largest economy in the second quarter matched the weakest expansion since 2009 as exports slumped.

While a collapse in commodities slammed manufacturing demand, tourism and cosmetics industries are benefiting from a 42 percent increase in visitors from China to 6.1 million last year, according to Korea Tourism Organization data. Health-care industries are emerging as winners in a country that will be home to the world’s oldest population by 2060.

The Bank of Korea’s record-low interest rate is helping to shore up domestic demand as the won’s 53 percent gain versus the yen since 2012 eroded export competitiveness overseas.

Large Caps

South Korea’s $1.2 trillion stock market, dominated for decades by so-called chaebols, is showing signs of transformation. The weighting of large caps in the benchmark Kospi index fell to 75 percent, the lowest since 2003, from 86 percent in 2012, according to data compiled by Bloomberg.

The government is providing assistance to small- and mid-sized companies in line with its drive to build a so-called “creative economy.” The finance ministry said in September that it will support smaller businesses with a 2 trillion won ($1.7 billion) state fund.

Hanmi Pharm Co. rallied fivefold to a record this year as the company was added to MSCI Korea Index. The medical stock valued at 115 times its prospective earnings. Dongbu HiTek Co. jumped 261 percent and Hana Tour Service Inc. more than doubled.

Larger companies lagged behind. Posco fell 31 percent as the nation’s biggest steelmaker battled a steel-price drop, and Hyundai Motor lost 14 percent. Daewoo Shipbuilding & Marine Engineering Co. tumbled 59 percent amid a glut of vessels, an oil price slump and low freight rates.

The Kospi Small Cap index fell 0.6 percent in Seoul at the 3 p.m. close in Seoul. The Large Cap gauge was little changed.

Earnings Divide

Soaring valuations for smaller companies beg the question as to whether the rally will extend, said Lee Jin Woo, a fund manager at KTB Asset Management Co. Even so, he sees the divergence between blue chips and growth stocks continuing amid better earnings prospects for smaller companies.

“Discriminating gems from pebbles is the key” after such a big rally, Lee said.

Profits for Samsung Electronics and Hyundai Motor fell for at least six straight quarters through June. Posco pledged this month to cut operations at home and abroad to focus on its main business after net income fell 61 percent last quarter.

By contrast, furniture maker Hanssem Co. reported a 59 percent increase in operating profit in the quarter ended June 30, while that of Korea Aerospace Industries Co. rose 67 percent in the period. Dongbu HiTek’s operating income jumped 73 percent in the 12 months through March 31.

“The thirst for growth is huge,” said KTB Asset’s Lee. “The macro environment abroad and at home isn’t encouraging for larger companies and the earnings outlook remains stagnant. Despite huge rallies among small caps, there’s no alternative.”

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