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As a team, we are embedded in emerging markets. Being on the ground across 15 countries, we see first-hand the transformation that has taken place in the last couple of decades—an evolution that in some areas is even accelerating amid COVID-19. This new reality in emerging markets is characterized by increased institutional resilience, improved economic diversification and the emergence of world-leading emerging market (EM) companies. In many cases these EM companies are leapfrogging developed market peers through new business models, often facilitated by superior infrastructure and intellectual property.
Institutional Resilience
South Korea stands out to us as illustrative of the aforementioned factors, and also as an example in terms of its handling of the COVID-19 pandemic. In our view, its exemplary response to the crisis reflects well on the quality of governance and social cohesion of the country. Similar to Japan, the country did not impose a lockdown, yet has achieved minimal deaths per capita.
The country has learned from previous regional health crises, and thus its economy and health system were prepared for this one. South Korea has for many years pursued prudent economic policies, resulting in low government debt. Crucially, it entered this crisis having had a negligible fiscal deficit of 0.3% last year, a fraction of the level of most developed markets.
Economic Diversification
In terms of the broader economy, South Korea has not been blessed with vast natural resources—on the contrary, oil imports are among the highest in Asia as a percent of gross domestic product. And despite having ample natural beauty and a rich distinctive culture, tourism has never been central to the economy.
The results are twofold. Near term, the country has disproportionately benefited from the crash in oil prices, while also seeing little economic impact from the collapse in international travel. But more importantly, over the longer term, Korea has invested in its people, in research and development, and has become an open economy—it’s an export powerhouse.
World-Class Companies
Furthermore, a number of South Korean exporters are of global importance, supplying hardware that enables the modern economy to function. World-leading semiconductor and battery makers are benefiting from the secular trends of increased computing power and greener mobility—some of which are accelerating due to the pandemic. Think of the massive increase in demand for cloud computing (and therefore data centers) driven by working from home and video conferencing. Or the potential uptick in e-bikes and car sales (an increasing proportion of which are electric) as people seek to avoid crowded public transport.
South Korea’s advantages in innovation and intellectual property are also evident in the health care sector—ranging from virus test kits to biologics—which have undoubtedly been supportive during this crisis. The country’s internet sector has also been thriving amid social distancing.
South Korea’s fiscal prudence is also replicated at the corporate level; the proportion of non-financial companies with net cash balance sheets is considerably above the global average (and more than double that of the United States).1 Viewed another way, cash holdings as a percent of total market capitalization are among the highest in the world. Balance sheets once derided as inefficient now look more appropriately conservative as companies globally seek government bailouts.
Admittedly, corporate governance has for a long time been a key challenge of investing in South Korea; complex chaebol holding structures, poor returns to shareholders and the more egregious issue of corruption have resulted in a discount being applied to many Korean companies. However, this is an area undergoing vast improvements, with a corporate governance code becoming compulsory for large companies (those listed on the KOSPI Index) in 2019. Various instances of engagement with companies are increasingly yielding results, evidenced by improving shareholder returns, public apologies and restructurings.
In short, South Korea exemplifies many of the trends we see increasingly driving emerging markets—an environment that facilitates superior earnings growth of globally competitive sustainable companies.
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1. Source: Bloomberg, based on MSCI Indexes. Excludes financial companies, as of April 2020. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. See www.franklintempletondatasources.com for additional data provider information.
