MSCI Defends Its View On Emerging Markets

ETF.com

 

While the world’s largest emerging markets ETF, the Vanguard MSCI Emerging Markets Fund (VWO), is letting go of its MSCI benchmark for a competing FTSE index early next year, MSCI is doing anything but conceding that perhaps its approach to indexing emerging stocks might have its pitfalls.

To the contrary, the index provider released a comprehensive white paper that details why the MSCI Emerging Markets Index and broad-based emerging markets investing in general is “as relevant as ever.”

At the heart of the matter is MSCI’s inclusion of South Korea in its emerging markets basket, a country that FTSE excludes from its emerging markets index and one that many consider more developed than developing. The results of MSCI’s next classification review will be released in June 2013.

Truth be told, when Vanguard first said early this month that it would ditch 22 MSCI indexes for cheaper FTSE and CRSP benchmarks in a process that shook up the world of indexing, it argued that the decision to do so was primarily cost-driven. FTSE and CRSP were offering credible indexes at a cheaper price.

"This is not about FTSE vs. MSCI," Joel Dickson, a principal at Vanguard's investor strategy group, said in a webinar hosted by IndexUniverse on the recent deal Wednesday. "It's about providing high quality indexes in the most cost effective way."

But the issue of Korea in the VWO portfolio quickly emerged, and it’s not a small matter given that roughly $9 billion of the $57 billion Vanguard ETF is tied to its Korea allocation. Other players in the world of developing markets, notably Emerging Global Advisors, have argued in their own white papers that investing in Korea is more like investing in the U.S. than, say, Eastern Europe.

Still, in this paper, MSCI broadly speaks to the different ways of approaching emerging market equities, even if nowhere in the 20-plus-page document does it mention its view on South Korea.

More broadly, the core of MSCI’s argument is that it believes that the nature of emerging market investing has changed in the past 20 years, but its role in investors’ long-term portfolio allocations hasn’t diminished.

“The changing nature of emerging markets means that the investment rationale underpinning the mandate allocations and the approaches to implementation have also evolved over time,” MSCI said in the paper, noting that many of these booming economies offer dynamically changing landscapes as their markets expand and as their financial markets grow deeper.

That changing landscape has meant that, by and large, emerging markets have seen a rising correlation with developed economies, making a current emerging markets allocation in a global portfolio more growth-oriented than one that addresses broad needs for diversification.

“The motivation for investing in emerging markets 20 years ago focused on gaining market exposure to an uncorrelated source of equity growth premium and was arguably often seen as an allocation outside the core portfolio,” MSCI said. “Today, many investors are seeing emerging markets as a core allocation in their portfolio.”

 

 

Losing VWO—as well as Vanguard’s other 21 ETFs—was a costly event for MSCI, which saw a disproportionate 25 percent of its market capitalization evaporate over indexing agreements worth an estimated $24 million a year, though the firm has annual revenue of more than $900 million.

At the end of the day, MSCI is counseling investors to stick to their knitting in terms of how they go about obtaining emerging markets exposure.

Yes, it agrees, strategies that either integrate developed and emerging stocks into one pile or those that look to pick the winners in the emerging markets space are gaining momentum with investors.

That said, a broad-based approach to emerging markets—read the MSCI Emerging Markets Index—is still a viable way to tap into the developing world’s growth premium.

A broad-based approach diversifies exposure across a constantly changing economic landscape, but it also dispenses with the need to pick winners, which is arguably a fool’s errand.

“Investors today have many choices in how they allocate to emerging markets,” Brett Hammond, managing director and head of MSCI Applied Index Research, said in a release that accompanied the report.

“However, we think that the broad-based emerging markets concept based on the MSCI Emerging Markets Indices has been effective in capturing growth in the segment while allowing investors to ride the changes in the underlying sources of economic growth premium,” he added.

 

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