The launch of the EGShares Emerging Markets Core ETF (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 (VWO) and the iShares MSCI Emerging Markets Index Fund (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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