South Korea and Taiwan have no business being classified as
emerging market countries and it's high time investors realize it,
according to a new paper by Emerging Global Advisors (EGA), the ETF
firm focused exclusively on investing in the developing world.
The EGA paper, "The Emerging Market Benchmark Bear Hug," is
strongly critical of broad market capitalization-weighted
benchmarks as investment tools for emerging markets-most notably
the MSCI Emerging Markets Index, which has 66 percent of emerging
markets equities tracking it
That's a reference, largely, to the $54.24 billion Vanguard MSCI
Emerging Markets ETF (NYSEArca:VWO) and the $39.67 billion iShares
MSCI Emerging Markets Index Fund (NYSEArca:EEM). Such funds put
investors in parts of the market that may not be truly emerging or
may not be the most primed for growth, the paper argues.
"We are not questioning the MSCI Emerging Markets Index's use as
benchmark," said EGA Chief Executive Officer Marten Hoekstra in an
interview with IndexUniverse. "We are questioning its use as an
Although the paper doesn't explicitly discuss the performance of
EGA's own 19 emerging market ETFs, the implied message is that the
company's funds focused on dividends, sectors and other themes are
probably a better way of accessing the rapidly changing world of
developing markets investment.
"We are trying create a tool set to allow people to express
their point of view in emerging markets similarly to the way they
can do in developed markets," added Hoekstra, noting that in
addition to currently offering a variety of sector and theme funds,
his firm is looking to develop its own emerging markets indexes in
the near future.
Also, EGA is on the verge of launching a varied group of 11
emerging market funds that include single-country ETFs, as well as
others focused on real estate and infrastructure, suggesting the
New York-based company picked an opportune time to knock the
broader benchmark indexed funds, which it is competing against.
According to the EGA paper, those who invest in broad-based
benchmark indexes, such as the MSCI Emerging Markets Index, may be
inadvertently putting their money into certain sectors that don't
merit large weights, or overlooking high-dividend stocks. Also, as
noted, the paper argues that some of the countries in the MSCI
index don't belong there, notably South Korea and Taiwan.
Both Asian countries earned developed-market status from the
International Monetary Fund in 1997, and therefore don't belong in
an emerging market portfolio, Emerging Global argues in the
In fairness to MSCI, the two countries are under review to be
promoted to developed-market status. They didn't pass muster in the
MSCI's annual classification review in June of last year, due in
large measure to what MSCI characterized as currency-convertibility
issues. But the two Asian countries remain under consideration for
promotion. MSCI will announce its findings in June, and the changes
would be implemented about 12 months later.
As an example, MSCI promoted Israel to developed-market status
in June 2009, but the changes didn't take effect until May
Throw Out Korea And Taiwan
The Emerging Global paper maintains that investors who typically
have a more sophisticated approach when investing domestically are
checking their logic and investment acumen at the door when it
comes to emerging markets, and ignoring potentially more lucrative
opportunities in sectors, dividend stocks and target funds.
One of the main points of the paper is that the 800-plus stock
MSCI Emerging Markets Index provides a combined weighting to South
Korea and Taiwan of about 26 percent.
The paper argues that this developed-market exposure is
diminishing the weight of both BRIC and non-BRIC EM securities
within the index.
In fact, according to the paper, the MSCI Emerging Markets Index
provides only a 46 percent weighting to all of the BRIC countries,
a part of the world where economists see tremendous potential for
growth in coming years. The paper didn't suggest an optimal amount
of exposure to BRIC countries.
Broad benchmark indexes also tend to emphasize sectors that
helped transform countries from frontier to emerging market status,
which comes at the expense of other sectors with the potential for
high growth, according to the EGA paper.
As such, the broad-benchmark emerging market indexes tend to
underweight growth opportunities in domestic demand sectors such as
telecommunications, utilities and consumer goods in favor of more
mature sectors such as financials, energy and materials.
For example, emerging-markets-based consumer companies make up
only 12.1 percent of the MSCI Emerging Markets Index, while
allocating almost a quarter to financials, according to the
"The projected growth of the EM middle class consumer is one of
the primary reasons that US investors are attracted to emerging
markets and yet our ECON fund [the Dow Jones Emerging Markets
Consumer Titans Index Fund (NYSEArca:ECON)], the largest EM-focused
consumer ETF, only has about $400 million in assets," Hoekstra
said. "This shows a major disconnect in how investors think about
emerging markets and how they actually execute their points of
To really profit from emerging markets, the paper suggests that
investors might want to take advantage of new products on the
market and target sectors and themes in emerging markets.
While it has a clear interest in seeing such an outcome,
Emerging Global also makes the case that investors in emerging
markets need to change their approach.
"Investing in an index with only a 12 percent weighting of EM
consumer goods and services companies is probably not an effective
solution for investors whose primary attraction to EM markets is
the middle-class consumer," Hoekstra said. "And if the
investment perspective is to be a yield buyer,
then owning an index that has a 2 percent yield makes even
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