1450 Korea Annual 2016 1450

KOREA EQUITY FUND, INC. December 21, 2016 To Our Shareholders: We present the Annual Report of Korea the KOSPI decreased from 2,016.19 to Equity Fund, Inc. (the “Fund”) for the fiscal 2,008.19, or 0.4% in local currency terms, year ended October 31, 2016. which, including the Won depreciation of 2.8% for the quarter, represented a total de- The net asset value per share (“NAV”) of crease of 3.2% in U.S. dollar terms. The the Fund increased by 2.1% and the closing NAV of the Fund decreased by 2.3% and market price of the Fund (on the New York out performed the KOSPI, in U.S. dollar Stock Exchange) increased by 6.2% after terms, by 0.9%. The Fund’s share price de- giving effect to the reinvestment of income creased by 2.0% during the quarter. dividends, ordinary income distributions, and long-term capital gain distributions for the fiscal year ended October 31, 2016. The South Korean Economy closing market price of the Fund on October The Bank of Korea (“BOK”) left its policy 31, 2016 was $7.89, representing a dis- interest rate at 1.25% for the fifth straight count of 7.7% to the NAV of $8.55. The net month in November 2016. This was based assets of the Fund totaled $83,292,709 on on the uncertainty over the policies of the October 31, 2016. incoming U.S. administration, a weaker domestic recovery amid a continued rise in The Korea Composite Stock Price Index jobless numbers, and various global risk (“KOSPI”) decreased from 2,029.47 to factors. The BOK noted growing uncertainty 2,008.19, or 1.1% in local currency terms, regarding the economic growth path due to for the fiscal year ended October 31, 2016. recent changes in domestic and global ex- Including the South Korean Won (“Won”) ternal conditions. In terms of policy direc- depreciation of 0.4% during the fiscal year tion, the BOK identified domestic and ended October 31, 2016, this represented a global external uncertainties and changes in total decrease of 1.5% in United States the U.S. Federal Reserve policy as key risks (“U.S.”) dollar terms. The NAV of the Fund for closer monitoring while focusing less on outperformed the KOSPI, in U.S. dollar the increase in domestic household debt. terms, by 3.6% during the fiscal year ended October 31, 2016. Korean exports decreased by 3.2% year- over-year (“yoy”) in October 2016, com- For the quarter ended October 31, 2016, pared with consensus expectations of a decrease of 3.1% yoy. Exports to the U.S. and ing expenditures by the Hyundai Motor China decreased by 10.3% and 11.3% yoy, Group. The Fund added Mando Corpora- respectively. Meanwhile, exports to Europe tion in November 2015 based on expecta- and the Southeast Asian Nations countries tions of improved earnings along with the increased by 3.8% yoy and 2.5% yoy, re- high-margin automobile component busi- spectively. ness. The Fund increased its position in Samsung Electronics Co., Ltd. Preferred in January 2016 due to expectations of im- South Korean Stock Market proved earnings from smartphone sales The Electronic Appliances and Compo- and a strengthened component business. In nents sector outperformed due to earnings May 2016, the Fund increased its position in growth expectations from rising new smart- Coway Co., Ltd. because the company’s phone shipments, better corporate gover- long-term competitiveness in the domestic nance, and a better outlook for the memory water purifier rental market. The Fund industry. The Iron and Steel sector also out- added Hyundai Engineering & Co., Ltd. in performed due to earnings growth expecta- August 2016 based on improved new order tions from improvements in steel prices momentum. The Fund added Halla Hold- through market consolidation in China. ings Corporation which owns 30.35% of Mando Corporation. The Fund expects im- On the other hand, the Textile and Ap- proved earnings momentum from Mando parel sector underperformed given con- Corporation to support better earnings cerns over weak new order momentum and growth for Halla Holdings Corporation. poor earnings. The Food sector also underperformed due to concerns that a slow- The Fund sold its position in SK Telecom down in domestic demand would cause Co., Ltd. in December 2015 because the earnings momentum to weaken. The Preci- Fund was concerned that slowing average sion Instruments sector underperformed revenue per use (“ARPU”) growth would due to concerns about weakened earnings hurt the company’s earnings going forward. and demanding valuations. The Fund sold its position in E-Mart Co., Ltd. in January 2016 as domestic discount store business growth has been slowing. Portfolio Management Activity The Fund disposed of positions in automo- The Fund added Korea Electric Power bile original equipment manufacturers Corporation in November 2015 based on (“OEM”), such as Kia Motors Corporation in improving financial stability and an attrac- December 2015 and Hyundai Motor Com- tive dividend policy. The Fund also added pany Preferred in August 2016, due to weak Youngone Corporation because of new or- shipment growth. The Fund disposed of der momentum is expected to improve and Lotte Chemical Corporation in August 2016 its attractive valuations. The Fund added In- in order to take profits amid oil price uncer- nocean Worldwide Inc. because the com- tainty. The Fund also disposed of its posi- pany may be a beneficiary of rising market- tion in Hyundai Green Food Co., Ltd. due to concerns that slowing growth among The Fund intends to maintain its over- Hyundai-related companies would hurt rev- weight exposure in the Electrical Appliances enue growth in the company’s catering and Components sector, including an over- business. The Fund disposed of its position weight position in SK Hynix, Inc., due to in Cuckoo Electronics Co., Inc. due to con- stable cash flow generation from the mem- cerns about weaker sales growth for rice ory chip business and its attractive valua- cookers and a slowdown in its rental busi- tions. The Fund increased its position in ness due to competition. The Fund also dis- Samsung Electronics, Co., Ltd., including posed of its position in Lotte Chilsung Bev- preferred shares, given stable earnings from erage Co., Ltd. given a slowdown in the component business and expectations beverage sales in the domestic market. of an improvement in corporate gover- The Fund participated in several initial nance. The Fund expects to keep an over- public offerings which contributed to the weight position in the Financing Business Fund’s realized gains during the fiscal year sector. Bank valuations are still attractive ended October 31, 2016. while profitability remains stable. Over- weight positions in selected insurance Investment Strategy stocks will also be maintained due to their stable revenue generation as well as an im- The Fund has a positive view on Asian proved regulatory environment. markets in light of continuing economic growth and supportive liquidity from central The Fund plans to maintain its under- bank action. The U.S. presidential elections weight exposure in the Chemicals sector did not produce a hawkish stance from the because of expected earnings volatility due U.S. Federal Reserve. Confidence that to uncertainty in oil prices. The Fund main- western economic policy interest rates were tains a positive view of Korea Zinc Co., Ltd., not increasing in the near term supported in the Iron and Steel sector, given stable Asian equity markets. earnings backed by capacity expansion as well as improving precious metals prices. The Fund maintains a positive view of the The Fund maintains its exposure in the Korean equity market. Although the eco- Transportation Equipment sector. Within the nomic recovery could falter and political un- sector, the Fund prefers automobile parts certainty could be prolonged, the Fund be- manufacturers to automobile OEMs as they lieves many stocks are undervalued and offer relatively stable earnings momentum under-owned which should limit further with margin expansion. Attractive valuations downside to the equity market. More corpo- should also offer some downside protection rate earnings reports have exceeded than to their share prices. missed their forecasts and there are more signs of corporate action amongst South Korean companies. The Fund upholds a positive view of stocks that generate stable cash flows with strong market positions. The Fund expects to keep its underweight The Fund appreciates your continuing exposure in the Telecommunications sector. support. Although regulatory risks and market compe- Sincerely, tition have been improving, there are concerns of slowdown in ARPU. The Fund also expects to keep its current exposure in the Utilities sector. The Fund upholds its positive view of the sector given steadily improving Yutaka Itabashi earnings and attractive valuations with higher President dividends. DISCLOSURES Sources: Nomura Asset Management U.S.A. Inc., Nomura Asset Management Singapore Limited, and Bloomberg L.P. Past performance is not indicative of future results. There is a risk of loss. The NAV price is adjusted for reinvestment of income dividends, ordinary income distributions, and long- term capital gain distributions. The New York Stock Exchange’s closing market price is adjusted for reinvestment of income dividends, ordinary income distributions, and long-term capital gain distributions. The Fund’s performance does not reflect sales commissions. This material contains the current opinions of the Fund’s manager, which are subject to change without no- tice. This material should not be considered investment advice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions, and each investor should evaluate their ability to invest for the long term.

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