The launch of the EGShares Emerging Markets Core ETF
(NYSEArca:EMCR) last week amounts to the latest punch thrown in an
ongoing debate surrounding the status of Korea and Taiwan. Are they
developed, as Emerging Global thinks, or are they developing as
some indexing firms say?
Both Korea and Taiwan have produced impressive and fairly
consistent growth, which has prompted debate to change their
commonly cited 'emerging' classification to what many consider to
be the more fitting 'developed' status.
Emerging Global's view is that huge companies from Korea or
Taiwan that are part of the market's biggest emerging market funds
are really multinationals, and deny investors access to local
economies, where the outsized returns are more likely, as middle
classes take shape in the developing world.
To put their economies in perspective, in terms of dollar-based
purchasing power, Taiwan's gross domestic product (
GDP
) of $887 billion is greater than the Netherlands' $713 billion,
according to 2011 estimates in the CIA World Factbook. South
Korea's even-larger GDP of $1.574 trillion exceeds that of both
Spain and Canada, at $1.432 trillion and $1.414 trillion,
respectively.
Reclassifying Korea and Taiwan from emerging to developed status
would have serious implications for the investment community, and
ETFs in particular, as my colleague Olly Ludwig noted in a past
article.
Two of the largest emerging markets funds, the Vanguard MSCI
Emerging Markets ETF (NYSEArca:VWO) and the iShares MSCI Emerging
Markets Index Fund (NYSEArca:EEM), for now, both still track the
same MSCI Emerging Markets Index. Together, they manage over $100
billion. These assets are only a drop in the big bucket of
institutional money that adheres to MSCI's country development
designations.
An Old Issue
The status of these two countries isn't a new question. MSCI,
widely considered to be the market leader in international
benchmarks, retained both Korea's and Taiwan's "emerging markets"
status in its annual classification review this past June.
Moreover, Taiwan and Korea have been up for review for the past
three and four years, respectively. But each review has produced
the same results, which begs the question of whether the big change
is imminent in the June 2013 review.
The timing of any changes to MSCI's classification system is
quickly becoming irrelevant, however, as other index providers have
already promoted South Korea to developed status. FTSE, for
example, pulled the trigger back in 2008 and S&P's Dow Jones
Emerging Market Index already excludes South Korea too.
FTSE isn't quite ready to promote Taiwan all the way to
developed status, but it goes part way by moving it from "secondary
emerging" to "advanced emerging," which is a primer category before
countries move to developed status.
S&P Dow Jones is less skittish on the subject and, similar
to South Korea, has already promoted Taiwan to developed
status.
Segments of the investment community have long since considered
South Korea and/or Taiwan to be developed countries, and Emerging
Global's "core" emerging markets launch is the most recent example
of that sentiment. EMCR, the new Emerging Global fund, tracks an
S&P emerging markets index that excludes South Korea and Taiwan
from the 'emerging' bucket.
The MSCI Rubric
MSCI focuses on three criteria when evaluating the development
status of countries:the level of economic development; size and
liquidity requirements; and market accessibility.
According to MSCI, the deficiency preventing Korea and Taiwan's
promotion is their failure to meet certain of the "market
accessibility" criteria.
MSCI noted in its June review that while Korea has made
significant progress toward these goals, it still needs to make
further progress in a few areas. Specifically, MSCI cited a lack of
currency convertibility due to the 'absence of an offshore currency
market,' which in itself presents further challenges.
Taiwan falls victim to the same lack of currency convertibility
that MSCI cites as its primary reason for not reclassifying the
country.
We'll have to wait until June to see if MSCI reclassifies Taiwan
and Korea as 'developed' countries.
Ultimately, development status is a subjective and contested
categorization. But it has real-world implications that extend
beyond the investment community.
Given the size of their economies, their income per capita, and
their relative stability and consistency, Taiwan and South Korea
certainly feel like developed markets to me.
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