Emerging Global Questions MSCI Dominance

April 02, 2012

South Korea and Taiwan are emerging market countries? Give me a break, Emerging Global argues in a new paper.


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 investment portfolio.”

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 paper.

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 2011.


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