When Are Emerging Markets Not Emerging Anymore?

March 17, 2010

Emerging markets are all the rage these days, and knowing which ETF is best is partly about realizing that all indexes are not created equal.

With emerging markets all the rage these days, the question of what constitutes an emerging market is becoming more important. Billions of dollars are riding on the answer as different ETF providers slice and dice the space differently, creating different ETFs with different returns.

Two leading emerging market ETFs—Vanguard’s VWO and EEM from iShares—are both based on the MSCI Emerging Markets Index, which for now includes Israel, Korea and Taiwan. However, Emerging Global Advisors, a New York-based newcomer to the ETF market, has decided to base its broad emerging market exchange-traded fund, EEG, on a Dow Jones index that doesn’t include the three countries.

Performance data on the Dow Jones Emerging Markets Titans Composite Index and the MSCI Emerging Markets Index are broadly similar, though the Dow Jones Titans Index has tended to rise and fall a bit more sharply than the MSCI index. Korea and Taiwan will remain part of MSCI’s Emerging Market Index at least until mid-2011, though
Israel will drop off in late spring, MSCI Barra said.

“We worked in consultation with the client and they wanted a more pure representation of emerging markets,” Richard Ciuba, senior director of business development and sales at Dow Jones Indexes, said in a telephone interview about Emerging Global. “If you included Korea and
, you would have seen they would have dominated those indexes, and really not given the client the total representation they were going for.”

How much a given country dominates an index matters less to MSCI Barra, which instead looks at how easy or difficult it is for foreign investors to gain access to a given market before it makes a decision about a given country’s classification, according to Frank Nielsen, executive director and head of applied and index research at MSCI Barra.

A competing exchange-traded fund, State Street Global Advisors’ SPDR S&P Emerging Markets ETF (NYSEArca: GMM), uses a benchmark that excludes Korea, but includes Taiwan and
. The SSgA fund is built on the S&P Emerging BMI Index, which categorizes
as a developed market.


MSCI Vs. Titans Vs. S&P Performance

MSCI Vs. Titans Vs. S&P Performance

Already Emerged?

The three countries—not least Korea, now one of the world’s top high-end manufacturers—don’t fit the emerging market profile anymore, according to Richard Kang, chief investment officer at Emerging Global. They all have per capita gross domestic product of more than $20,000 a year and have established middle classes, disqualifying them from the International Monetary Fund’s definition of an emerging market.

“You go there—to Incheon Airport in Seoul, or you go to Taipei or Tel Aviv and look at their airports, and it’s La Guardia [in New York] that looks like the third world, it really does,” said Kang in a telephone interview. “Everything looks and feels like a developed economy,” he said, referring to the three countries. They all have vibrant health care and technology industries and few poor people, unlike most emerging market countries that rely on natural resource exports and are often teeming with poverty.

When counted as emerging markets in an index, the three countries make up big percentages of any index fund, potentially playing an outsized role in any portfolio that’s designed to take full advantage of the high growth rates that emerging markets offer investors.


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