By Ankur Banerjee and Vidya Ranganathan

SINGAPORE (Reuters)

Global investors have consistently valued South Korea lower than other markets, influenced by factors like tensions with North Korea and the structural complexities of its conglomerates. This week’s political developments heightened this trend.

Market Reaction

Korean stocks plummeted and the won dropped to two-year lows on Tuesday after President Yoon Suk Yeol unexpectedly declared martial law in the export-driven economy.

However, the effects were brief as Parliament quickly overturned the ruling, leading to market stabilization. Despite this, investors were reminded why Korean stocks and the currency have lagged behind global indices recently.

Daniel Tan, a portfolio manager at Grasshopper Asset Management, remarked, "In the longer term, the martial law episode would accentuate the 'Korean Discount', an elevated risk premium with trading Korea-related assets, equities, FX, and bonds. Investors could require a bigger risk premium to invest in the won and Korean equities."

Understanding Korea’s Discount

Korea's so-called "discount" refers to the low prices of stocks in the KOSPI 200 index, particularly when compared to the companies' assets or their price-to-book (P/B) ratios. A significant number of KOSPI-listed firms trade at a P/B below 1, a stark contrast to the MSCI world index, which trades at a ratio of 3.5.

The latest political upheaval coincided with ongoing conflicts between President Yoon and the opposition-controlled parliament regarding budget issues and various scandals. On Wednesday, opposition lawmakers pledged to seek the president's impeachment, while the Chosun Ilbo reported potential mass resignations in the cabinet.

Factors Contributing to the Discount

Several reasons sustain Korea's persistent discount:
1. Ongoing tensions between North and South Korea create risk.
2. The prevalence of family-run chaebols, which are often non-transparent and do not provide substantial dividends.
3. The share price for major companies like Samsung Electronics (KS:005930) shows a lower earnings multiple compared to regional competitors like Taiwan Semiconductor Manufacturing Co. (TSMC).

Korea's discount worsened this year as investors grew increasingly concerned about the nation's exposure to China, which is struggling with a sluggish economy and new U.S. trade tariffs. The won has depreciated by 9% against the dollar this year, while the KOSPI index has declined by 7%, both underperforming their emerging market counterparts.

Sat Duhra, a portfolio manager at Janus Henderson, noted, "Despite the market being cheap and having underperformed—usually an attractive factor for investors—there's not enough assurance for the won’s stabilization. I don’t plan to increase my exposure to Korea amid this uncertainty."

Investment Trends

Since August, foreign investments in Korea’s stock market have been declining, with outflows surpassing $14 billion over the past four months.

Though money has flowed into high-yielding bonds, investors may become cautious about these securities if the ongoing political turmoil leads to President Yoon’s impeachment or other significant changes, like snap elections or increased spending commitments from major political parties.

While officials attempted to support the won and stabilize financial markets on Wednesday, investors remain apprehensive about future developments concerning the currency.

Rob Carnell, ING's regional head of research for Asia-Pacific, shared his insights: "In the near term, it seems challenging for the won to perform well due to a terrible structural backdrop, a weak domestic economy, and expected central bank easing. Additionally, the dollar’s relative strength exacerbates these issues."