Korea Fund: Worth A Look As Discount Narrowing Path Emerges

seekingalpha07-14

The closed-end Korea Fund has benefited from a narrowing NAV discount.Expect more of the same ahead of a potentially catalyst-rich next few months.Despite its flaws, KF ticks a lot of boxes as a ...

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With the closed-end Korea Fund (NYSE:KF), on the other hand, investors get to profit from a third factor – a narrowing fund-specific discount to net asset value (or 'NAV'). Data by YCharts Admittedly, the safety margin isn't quite as wide as it was when I last covered KF (see Korea Fund: The Wind Is Still In Its Sails) now that the NAV discount has narrowed post this month's tender offer announcement. Yet, the option value here is arguably also deeper 'in the money' now that the Board, no doubt pressured by growing activism within the shareholder base, is starting to commit to increasingly shareholder-friendly measures. All in all, KF screens favorably as an interesting and potentially catalyst-rich way to play Korea. Data by YCharts KF Overview – Mostly Status Quo Fundamentally, not too much about the actively managed Korea Fund has changed. This includes the manager (JPMorgan), the bottom-up philosophy, as well as the MSCI Korea 25/50 Index benchmark. By virtue of its early 1984 inception, the fund is also the longest-tenured within the US-listed universe. Korea Fund That said, its ~$144m managed asset base, while slightly larger than before, continues to trail both iShares' MSCI South Korea ETF (EWY) and the Franklin FTSE South Korea ETF (FLKR). Less size typically means less liquidity, lower volumes, and wider bid/ask spreads, which, in turn, entails costlier execution. It also leaves the manager with less of an asset base to spread its expenses over; hence, the relatively uncompetitive ~1.5% expense ratio (70bps in manager fees). Korea Fund For now, there hasn't been any meaningful move by the Board to address the expense gap (note EWY and FLKR charge ~0.6% and ~0.1%, respectively). The good news, though, is that the direction of travel is getting incrementally more positive, with a renewed focus by the Board on \"investment performance and fund expenses\" (per KF's semiannual report) followed by a tender offer this month (more detail in the performance section below). KF Portfolio – 'Big Tech' Overweight Intact The KF portfolio has been trimmed slightly to 54 holdings this quarter, though the overall portfolio composition remains, for the most part, unchanged. At the sector level, the fund has the same three overweights relative to its benchmark - Information Technology (41.6% vs. 37.6%), Financials (15.2% vs. 13.2%), and Materials (8.2% vs. 6.9%). The biggest underweight remains Industrials (6.8% vs 14.8%), while KF's other sectors are very much in line with MSCI Korea 25/50. Korea Fund Like the other US-listed Korea funds, KF has both of Korea's flagship tech names, Samsung Electronics (via common (18.1%) and preferreds (4.9%)) and SK Hynix (HXSCF) (11.5%) as its top holdings. The main selection differences are on the ex-tech side, for instance, the preference for Shinhan Financial Group (SHG) over KB Financial (KB) and LG Chemical over POSCO (PKX) on the Materials side. Meanwhile, the narrower portfolio (54 stocks vs 99 stocks for EWY) and high concentration (~57% from top ten holdings) mean KF is likely more levered to broader market movements. For the most part, though, both passive (EWY and FLKR) and active (KF) options overlap quite a bit and should, therefore, track each other quite closely through the cycles. Korea Fund If there's one other thing that stands out from KF's portfolio, it's the valuation, which indicate its stock selection skews slightly more toward the value-oriented. Of note, KF maintains a lower portfolio-level multiple on earnings (10.9x trailing vs. 13.6x for EWY) and book value (0.95x vs. 1.13x); the latter, in particular, positions the fund to benefit from a successful \"Value-Up\" (recall the program targets low P/B names). Still, investors are paying a premium expense ratio for KF, and it's unclear to me if the selection is material enough to justify the added cost. KF Performance – Tender Offer Triggered; Activist Optionality Keeps NAV Discount in Play  As I highlighted previously, KF hasn't quite lived up to total return expectations after 2021, when JPMorgan took over. While things have turned around in recent months, no doubt helped by KF's tech overweight, it wasn't quite enough to reverse the fund's ~32bps underperformance vs its benchmark MSCI Korea 25/50 Index over the April 2021 to June 2024 period. The silver lining is that this performance shortfall has triggered a performance-linked tender offer, which, per KF's 1st July release, will see the fund \"conduct an issuer tender offer for up to twenty-five percent (25%) of its then issued and outstanding shares of common stock on or before September 30, 2024.\" The catch, though, is that the original terms dictate that the \"size\" and \"price at which shares are to be tendered\" are at the Board's discretion. Thus, the follow-up 10th July release outlining Board authorization for a tender offer to purchase for cash up to 12.5% of outstanding shares \"at a price per share equal to 98.5% of the NAV per share\" is the more pertinent one. While not quite the best-case scenario (e.g., a full tender offer for 25% of outstanding shares at NAV), in context of the minimal underperformance over the measured period, this seems like a fair outcome for shareholders, in my view. It's also worth noting that KF's historically stubborn NAV discount has narrowed to ~12% on the news. Data by YCharts In other words, the market has reacted positively to the tender offer. But perhaps not too positively, considering the market-implied pricing for the rest of KF's outstanding shares is an ~14% discount to NAV (in line with the average rate pre-2020). Morningstar From here, the question remains: can KF's NAV discount narrow further (allowing KF to outperform passives)? Or is this as good as it gets (in which case a low-cost passive fund would be preferable)? Given the fund's overly high expense ratio, there's an argument that a low teens % discount is far too narrow. But this would ignore the attractive optionality here, even if it's not as 'cheap' as it used to be; note the activist presence on KF's shareholder roster, including City of London (~25%), 1607 (~9%) and to a lesser extent, Saba (<1%)). FT Plus, there's an on/off buyback (part of the fund's \"Discount Management Program\"), another performance-linked tender (2024-2027), and an increasingly shareholder-friendly tone by the Board to account for, all of which should keep the discount anchored for a while. And in the more immediate term, with the current tender offer due by September and an annual report (for the fiscal year through June 2024) also due very soon, I would stick around for now. Worth a Look as Discount Narrowing Path Emerges  The Korean investment case may have suffered a setback following the government's legislative election losses, but recent indications from an upbeat H2 2024 economic policy update and export growth data indicate that fundamentals remain very solid. Investors looking for additional margin should find a lot to like in the closed-end Korea Fund, which features not only a portfolio richer in low P/B \"Value-Up\" beneficiaries than its passive comparables, but also an increasingly attractive path toward narrowing its discount to NAV.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2451872926"}