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Guest Article: North Korea: The Ultimate Final Frontier Market

Geoffrey See

Choson Exchange

13 February 2013

Editor’s note: The term “frontier market” is bandied about quite a good deal in the investment world and this publication, like others, gets its fair share of views about countries seen as promising for those willing to take on the requisite risk. But very few mention North Korea, a jurisdiction that has been run by a hard-line communist regime since the early 1950s and which is infamous for its mix of personalty-cult leadership, repression and lack of contact with the outside world. The jurisdiction was back in the headlines this week over reports of a further nuclear test, which has provoked international condemnation. In the light of such things, is there an investment case that can or should be made for this place?

Geoffrey See, who is the managing director of Choson Exchange, his eponymous non-profit organisation focused on business, economics and legal education for young professionals and policymakers in North Korea, gives his views about the country. See has advised hedge funds and private equity firms about North Korea; he has also worked at Bain & Co. His views here are not necessarily endorsed by this publication, but it is delighted to share the insights about what might one day be a country more familiar to investors than it currently is. (Choson Exchange has offices in Beijing, Singapore and Boston.)

This question must seem utterly contrarian with the recent North Korean nuclear test, coming on the heels of a rocket test, and the likely chorus of think tank voices that will follow calling for increased sanctions. Given the obsessive secrecy that shrouds North Korea and its tendency to be in the news for the wrong reasons, it is unsurprising that most western investors overlook the country. However, niche interest in North Korea is rising among some American, European and Southeast Asian investors, not to mention increasing investments from mainstream Chinese investors. Hedge funds trade defaulted North Korean debt instruments while other investors take stakes in various commodity, property and retail opportunities.

I recently spoke at a conference a hedge fund organised for their investors. The fund had some exposure to North Korea. For investors looking to the long-term and interested in yield, it is easy to see why this niche interest exists. After all, a friend who provides working capital loans in Pyongyang charges interest greater than 50 per cent on an annualised basis to the more reputable borrowers in the country – an indication both of opportunity (scarce capital) and risks (potential for default).

But is North Korea invest-able for more mainstream investors?

The answer to this question is unfortunately a non-resolute perhaps…North Korea is slowly opening its market to foreign investors. But foreign businesses in North Korea still struggle with weak governance, arbitrary rules and an opaque operating environment. 

Theory and practice

Emerging markets fund manager James Passin, in an interview with Bloomberg News recently, said how North Korea has geographical and natural advantages that favor its growth. Like nearby Mongolia, which has seen an incredible resource-driven boom over the last five years, North Korea has abundant underground resources that include coal, gold, and iron. Similar to Mongolia, North Korea is situated next to booming China, dynamic South Korea and affluent Japan, and well placed to benefit from these markets. Unlike Mongolia, North Korea’s larger population, at around 25 million, has the potential to become a manufacturing hub and emerging consumer market.

Such potential is of course highly theoretical and realisable only in the longer-term. North Korea has resisted traditional development options for many years through a mix of inconsistent economic policies, paranoid security measures, and the inability to provide infrastructure to would-be investors. Simple decisions are hampered by a bureaucracy that clings to secrecy – when we ask investment policymakers how an entrepreneur would apply for licenses for certain businesses, the typical response would be “I don’t know…but try and find out.”

Despite the gap between present performance and long-term potential, I am cautiously optimistic about the next five years. Aid, trade and investments from Russia and China have increased significantly over the last five years, and are likely to grow over the next five years. A newly elected South Korean government might re-engage with North Korea with investment and aid.

A critical factor that has escaped the attention of many observers is how mindsets have changed. There is an active entrepreneurial community on the ground in North Korea. This community does not just include the well-documented informal markets where small stall owners peddle a range of products, but also includes ex-government officials or state-owned enterprise managers who set up relatively large businesses in industries ranging from restaurants to property development. A venture capitalist who joined an education programme we conducted in North Korea remarked that this rampant commercialism reminded him of the early years of the Chinese economic take-off.

This entrepreneurial energy if rightly channeled can lead to significant economic growth. The North Korean government has committed itself publicly to developing the country, and has been making it easier for investors to navigate the system, albeit at a lethargic pace.

Choosing the right route

For financial investors, private equity is the most appropriate instrument given the limited range of liquid instruments providing exposure to North Korea and the time horizon needed to realise a return.

Effective execution is the key to success in the North Korean market, and the companies that we know to have done relatively well in the market tend to share a few characteristics: significant hands-on involvement in operation and governance, boots on the ground, quality relationships with North Koreans who can be trusted, and a broad network in the country that facilitates due diligence and troubleshooting. Unfortunately, successes are still relatively rare, and investors need to go in fully aware of the challenges of this market.