Zaks Investment Advisory Service

BRIC Alternatives: Turkey and South Korea; Fast-Growing Markets

Today, I will be concluding our series of programs devoted to emerging markets. We will be coming back to these from time to time, but only sporadically so. For example, one day I would like to tell you about why I find emerging nation markets so attractive: this is actually a far more complicated question than it might appear at first glance. But now, I would like to tell you about two other of the more developed emerging nations, Turkey and South Korea, as well as about which regions enjoyed the fastest growth over the past five years.

We begin with Turkey. Turkey holds a unique position: it is a large Muslim country whose land partially stretches into Europe. It emerged from the ruins of the Ottoman Empire after Word War I to a large extent thanks to the efforts of one person, Mustafa Kemal Ataturk. Ataturk saved the empire from inevitable annihilation at the Battle of Gallipoli, and several years later became the first president of a republic that rose in its place. His mission was to make Turkey into a modern, secular and democratic state. Things failed to work out on the democratic front for quite a while – Turkey remained a one-party state for much of the 20^th century, at times even falling under the army’s control, but it did become a secular state. The economy was modernized as well: from a backward one based on agriculture, Turkey turned into a quite modern nation with a fairly developed infrastructure and open economy. Turkey would very much like to ascend to the European Union, which is rather ambivalent about such a turn of events. In order to have any real chance of making it into Europe, Turkey must first undertake numerous political and economic reforms, liberating both systems. Steps in this direction are having a positive effect on the country’s economy and also its stock exchange, which has gained more than 300 percent over the past five years. One may presume that Turkey will continue its liberalization policies in the coming years. For foreigners, this is a good omen. Until recently, opportunities for US investors interested in funds specializing in Turkey were limited to just one closed-end fund. But three weeks ago, as if to mark the occasion of our programs, Barclays Bank launched an exchange-traded fund that tracks the Istanbul exchange.

It’s probably a stretch to call South Korea an emerging country. South Korea’s per capita GDP is significantly larger than that of BRIC nations, for example. Nevertheless, it is still about a third smaller than the European Union’s average GDP. So formally, South Korea is still ranked among the emerging nations. South Korea’s history is stunning: it was one of the poorest countries in the world after the Korean War. And now, as I have said, it is approaching Western European standard of living. In 1963, South Korea’s per capita GDP was $100. In 1995, it was $10,000. South Korea’s economy has matured in recent years and the pace of its growth has subsided somewhat. Still, Goldman Sachs, investment bank which likes to make long-term (and often-extravagant) forecasts, believes that by 2050, in per capita terms South Korea will become the world’s second-richest nation after the United States. The recent history of South Korea’s economy is so fascinating that it could merit its own program, especially since its example is quite instructive for the analysis of other emerging nation economies. But what interests us most about South Korea now is not its economy so much as its stock exchange. Over the past five years, its prices have grown slightly slower than those of other emerging nation exchanges. The KOSPI index (which is South Korea’s counterpart to our S&P 500) has gained about 200 percent over this span. But on the whole, the rise in South Korea’s exchange prices fails to correspond to its phenomenal economic boom. In 1980, the KOSPI index stood at 100 points. Now, it is around 1,800. In other words, over the past 28 years, the index recorded an average annual gain of 10 percent – sometimes more, and sometimes less. For example, between 1989 and 2005, the KOSPI was almost stagnant. For a country developing as fast as South Korea, this is an unexpectedly middling result. This only provides more testimony to the fact that economic growth and the rise of stock exchange prices are not always correlated. What is putting the breaks on a rise in the price of South Korean company shares? I believe the main reason is linked to South Korea’s corporate ownership structure, which is called the “chaebol.” Chaebols represent huge conglomerates that are controlled by a small group of families. These conglomerates have dominated the economy for many years and still largely continue to do so today, despite several administrations’ attempts to reform the system. Inside the chaebol itself, one group of companies controls another; they even provide each other low-interest loans. With such a structure in place, small independent investors become outsiders. Their rights are often sacrificed in favor of the corporation’s own growth, whether this benefits the investors or not. It comes as no surprise, then, that stocks end up being undervalued. The process of South Korean economic reforms continues, still aiming to make the corporate structure more transparent and responsible to investors. This process, combined with the ongoing economic growth, allows us to presume that South Korean stock prices will continue to grow. US investors interested in South Korea have access to a fairly wide range of mutual and closed-end funds, as well as one exchange-traded fund.

And now, a few words about the world’s fastest-growing stock exchanges. In one of our previous programs, I mentioned that the Ukrainian exchange was one of the world’s strongest over the past five years: it grew by a factor of 16. The stock exchange in Egypt, a country that we rarely think of as a suitable place for investment, shot up 1,400 percent over the same span. The exchanges of Middle Eastern oil- and gas-exporting nations also grew incredibly fast, which is hardly surprising considering the current price of oil. After many years of stagnation, several African countries have also undergone substantial economic reforms. Analysts believe that this will finally help them start to grow. These, of course, are risky investments. But if they turn out to have come at the start of an extended period of growth, these investments may turn into incredibly lucrative ones, too.

And with this, we will draw today’s program to a close. I would like to caution my listeners that our next program will air in three weeks, on Tuesday, May 20, at about 7:30 am, and on Thursday, May 22, at 8:15 am. This was Sergey Zaks. Thank you for your attention and until next time.