Pension Funds Ignore Kim as Korean Stock Valuations Drop

South Korea’s biggest investors are buying more equities than ever at a time of worsening relations with North Korea, lured by the cheapest shares since 2007.

Domestic institutions bought a net 2.2 trillion won ($1.97 billion) of stocks in the two weeks after North Korea announced its highest combat level on March 26, the first among escalating threats from Kim Jong Un’s regime. The purchases were larger than those following seven previous flare-ups, from North Korea’s first nuclear test in 2006 to its detonation of a nuclear device in February, data compiled by Bloomberg show.

While the Kospi index has retreated 3 percent since March 26 amid 2.2 trillion won of net equity sales by foreigners, Korea Teachers Pension and Shinyoung Asset Management Co. added to holdings as valuations fell to the lowest level in six years relative to the MSCI Asia Pacific Index. Investors who bought Kospi shares in the two weeks after previous bouts of tension were rewarded with three-month gains of 5 percent on average.

“There’s ample upside in the Kospi this year from the current level,” Young Soo Shim, the head of asset outsourcing team at Korea Teachers Pension, the nation’s second-largest public pension fund with the equivalent of $12.5 billion under management, said by phone on April 12. “We spent more than initially planned in March as we have flexibility in executing money, with North Korea continuing to ratchet up threats.”

Relative Valuations

The 764-stock Kospi is valued at 1 times net assets, versus 1.5 times for the MSCI Asia Pacific Index, the widest gap on a monthly basis since March 2007, according to data compiled by Bloomberg. SK Innovation Co., a Seoul-based oil refiner, has a multiple of 0.8, compared with an average of 2 for Asian peers. E-Mart Co., the country’s biggest discount-store operator, trades for 10 times estimated 12-month earnings, the lowest level in a year.

The Kospi rose 0.1 percent to 1,923.84 at the close in Seoul today. The gauge has lost 3.7 percent this year, compared with a 6.1 percent gain in the MSCI Asia Pacific index.

South Korean shares have lagged behind regional equities since the end of March as North Korea cut off a military hotline, declared a state of war with the South, threatened pre-emptive nuclear strikes and prevented South Korean workers from entering a jointly run industrial park in Gaeseong.

Miscalculation Risk

North Korea said yesterday it doesn’t oppose resuming dialogue with the U.S., according to a statement from a Foreign Ministry official who wasn’t identified on the Korean Central News Agency. President Barack Obama said in a recorded interview broadcast on NBC’s “Today” show that North Korea probably isn’t able to launch a nuclear-tipped missile. Earlier, a U.S. military official said that Kim’s inexperience raises the risk of miscalculation, while he’s unlikely to launch a missile that directly threatens South Korea.

Stock declines are “an opportunity to add blue chips at bargain prices,” the National Pension Service, South Korea’s biggest investor with about $350 billion in assets as of January, said in an e-mailed response to questions on April 11. The press office didn’t say whether the pension fund is currently buying shares.

“Many domestic institutions appear to be betting that the impact on sentiment will be temporary and the frosty relations would thaw again going forward,” Nam Dong Joon, the head of equities at Samsung Asset Management Co., which oversees $115 billion, said by phone on April 11. “I believe the latest tensions surrounding the Korean peninsula have also been overstated to an extent.”

Yen Concern

Slower economic growth and a weaker yen are also weighing on South Korean shares. The Bank of Korea cut its growth forecast for this year on April 11 to 2.6 percent from a January estimate of 2.8 percent. The central bank kept its benchmark seven-day repurchase rate at 2.75 percent for a sixth month on the same day, resisting government pressure for a reduction.

The yen has weakened about 19 percent against the won in the past six months as Japan’s central bank announced plans for unprecedented monetary stimulus, hurting the competitiveness of South Korean exporters. Hyundai Motor Co., South Korea’s biggest automaker, has tumbled 16 percent during the period while Japan’s Toyota Motor Corp. rallied 80 percent in Tokyo.

Warship Attack

“It’s not good news for companies that compete head-on with Japanese names such as autos and electronic components,” Colin Kim, the head of portfolio management at the financial engineering division of Mirae Asset Global Investments Co., said by phone yesterday. “Still, the yen’s depreciation has been so steep, and I think such a pace will moderate a bit from the current level.”

Investors who bought South Korean shares during previous periods of heightened tension made money on average during the three months that followed, data compiled by Bloomberg show. The Kospi rallied 16 percent after North Korea’s second nuclear test in May 2009, 11 percent following Kim Jong Il’s death in December 2011 and 2 percent after the North’s artillery attack on the border island of Yeonpyeong in November 2010.

The index gained 1 percent after the sinking of the South Korean warship Cheonan in March 2010. It was little changed following the North’s rocket launch in December 2012 and its first nuclear test in October 2006. The three-month return measurements began two weeks after each event.

Domestic institutions have been net buyers during the past four instances of strained relations, purchasing about 418 billion won of shares on average, data compiled by Bloomberg show.

E-Mart Outlook

Valuations of refiners such as SK Innovation has become more attractive after shares fell, Woori Investment & Securities Co. wrote in an April 11 report. SK, the owner of South Korea’s largest oil refiner, has dropped 12 percent since March 26. Its price-to-book ratio of 0.8 is the lowest since June.

E-Mart, which has declined 9.9 percent since March 26, is poised to rally 25 percent in the next 12 months, according to the average of 19 share-price estimates compiled by Bloomberg.

“We have been buying stocks,” Huh Nam Kwon, chief investment officer at Shinyoung Asset Management, which oversees about $5 billion in Seoul, said by phone yesterday. “Previous cases have proven that buying on dips that were triggered by geopolitical tensions later turns out to be profitable.”