South Korea Equity Strategy

KOSPI Outlook: Structural Transformation Amid Elevated Volatility

Executive Summary

The South Korean equity market is entering a defining phase of structural transition. Following a sharp rally driven by artificial intelligence (AI)-related optimism and government-led capital market reforms, the KOSPI has recently experienced heightened volatility as stretched valuations, leveraged positioning, and profit-taking converged.

While near-term market conditions remain uncertain, we believe Korea's long-term investment case continues to improve. The trajectory of the KOSPI will increasingly depend on three structural themes: sustained global AI investment, continued corporate governance reform, and the gradual elimination of the long-standing "Korea Discount."

Although downside risks remain elevated, the medium- to long-term outlook appears constructive, provided earnings growth and policy execution remain intact.

Investment Thesis

The Korean equity market remains one of Asia's most cyclical yet strategically important investment destinations. As one of the world's leading exporters of semiconductors, automobiles, batteries, and advanced manufacturing technologies, Korea is uniquely positioned to benefit from the next wave of global technological transformation.

However, despite these competitive advantages, Korean equities continue to trade at valuation multiples below those of major developed markets due to persistent structural inefficiencies.

We believe investors should increasingly differentiate between cyclical volatility and long-term structural improvement.

Structural Challenges

1. Semiconductor Concentration Risk

The KOSPI has become increasingly concentrated in semiconductor-related companies, particularly Samsung Electronics and SK Hynix.

As artificial intelligence infrastructure spending has accelerated globally, these companies have emerged as the primary beneficiaries of rising demand for advanced memory products, including High Bandwidth Memory (HBM).

While this concentration has significantly boosted index performance during periods of optimism, it has also increased downside sensitivity whenever expectations surrounding AI investment weaken.

Unlike the U.S. equity market, where sector diversification provides greater stability, Korea's benchmark index remains disproportionately exposed to a single industry cycle.

Consequently, fluctuations in semiconductor earnings expectations frequently translate into substantial movements across the broader market.

2. Retail Leverage and Market Instability

Retail investor participation has become a defining characteristic of the Korean market.

The rapid expansion of leveraged ETFs and concentrated positioning in a limited number of technology companies amplified market momentum during the rally.

However, leverage works symmetrically.

As prices corrected, forced liquidations accelerated downside momentum, significantly increasing short-term volatility.

This episode highlights an important structural vulnerability: excessive retail leverage can transform ordinary market corrections into disorderly selloffs.

Future regulatory adjustments may reduce systemic risk, although investor behavior will remain an important variable.

3. Korea Discount Remains a Structural Headwind

Despite strong global competitiveness across several industries, Korean companies continue to trade at persistent valuation discounts relative to international peers.

This "Korea Discount" reflects multiple structural factors, including:

• Limited shareholder returns
• Complex corporate governance structures
• Cross-shareholding within family-controlled conglomerates
• Historically conservative dividend policies
• Geopolitical uncertainty on the Korean Peninsula

Recent government initiatives aimed at strengthening shareholder rights, improving governance standards, encouraging treasury share cancellation, and enhancing capital allocation represent meaningful progress.

Should these reforms continue, valuation multiples could gradually converge toward those observed in other developed equity markets.

4. Dependence on Foreign Capital

Foreign institutional investors remain the dominant marginal buyers and sellers within the Korean equity market.

Consequently, capital flows are influenced not only by domestic earnings but also by global macroeconomic conditions, including:

• U.S. monetary policy
• Dollar liquidity
• Exchange-rate movements
• Global risk sentiment

Periods of U.S. dollar strength or rising Treasury yields have historically resulted in capital outflows from Korean equities.

Conversely, improving global liquidity conditions generally support renewed foreign buying.

As such, macroeconomic developments outside Korea often exert greater influence on market performance than domestic fundamentals alone.

5. Increasing Correlation with the Global AI Cycle

Korea has effectively become one of the world's most direct equity exposures to artificial intelligence infrastructure spending.

Investment decisions by global hyperscalers—including Microsoft, Amazon, Meta, Alphabet, and other major cloud providers—directly affect demand expectations for Korean semiconductor manufacturers.

As AI capital expenditures continue to expand, earnings visibility for Korea's technology sector should remain favorable.

Nevertheless, any moderation in AI infrastructure investment would likely trigger a corresponding re-rating across Korean technology equities.

Therefore, monitoring the global AI investment cycle has become increasingly important for assessing the KOSPI's future direction.

Key Catalysts

Several developments could support a sustained re-rating of Korean equities over the coming years:

• Continued growth in global AI investment

• Expansion of High Bandwidth Memory (HBM) demand

• Improvement in corporate governance

• Higher dividend payouts and shareholder returns

• Treasury share cancellations

• Increased participation by foreign institutional investors

• Stable domestic monetary policy

Collectively, these factors could contribute to a gradual narrowing of the Korea Discount.

Principal Risks

Despite improving structural fundamentals, investors should remain aware of several downside risks.

These include:

• A slowdown in global AI investment
• Intensifying semiconductor competition from China
• A prolonged global economic slowdown
• Unexpected shifts in U.S. monetary policy
• Renewed geopolitical tensions
• Delays in implementing governance reforms
• Structural demographic challenges, including population decline and labor force contraction

Any combination of these factors could delay the valuation recovery currently anticipated by investors.

Outlook

Short-Term (3–6 Months)

We expect market volatility to remain elevated.

Investor sentiment will continue to be driven primarily by:

• AI-related earnings
• Foreign institutional flows
• Federal Reserve policy expectations
• Semiconductor pricing trends

Although periodic corrections remain likely, earnings resilience should provide fundamental support.

Medium-Term (1–3 Years)

Our medium-term outlook remains constructive.

Provided corporate earnings continue expanding and governance reforms remain on track, Korean equities possess meaningful upside potential relative to current valuation levels.

Foreign ownership is likely to increase as structural reforms improve market accessibility and shareholder confidence.

Long-Term (5–10 Years)

We maintain a positive long-term strategic view.

South Korea possesses several enduring competitive advantages:

• Global leadership in advanced semiconductor manufacturing
• World-class technology companies
• Strong export competitiveness
• Increasing emphasis on shareholder value creation
• Government commitment to capital market modernization

If these structural trends continue, we believe the KOSPI has the potential to evolve from a traditionally cyclical emerging-style market into a higher-quality developed-market investment destination.

Investment Conclusion

Our long-term assessment of Korean equities remains Moderately Overweight.

While short-term volatility is expected to persist amid global macro uncertainty, we believe structural improvements are gradually strengthening Korea's investment profile.

The combination of AI-driven earnings growth, improving shareholder returns, enhanced corporate governance, and capital market reform provides a compelling foundation for long-term value creation.

For institutional investors, periods of heightened volatility should be viewed not solely as sources of risk, but also as opportunities to accumulate high-quality Korean companies at attractive valuations.

In our view, the central question is no longer whether Korea can participate in the next phase of global technological transformation, but whether investors are fully recognizing the structural improvements underway.

Should current reforms continue and earnings momentum remain resilient, the KOSPI could experience a sustained valuation re-rating over the coming decade, narrowing the historical Korea Discount and strengthening its position within global equity portfolios.