What’s In Your International Equity ETF?

How index providers classify global markets and what this means for international equity ETFs.

Reviewed by: Jessica Ferringer
Edited by: Jessica Ferringer

When it comes to international equities, most investors are familiar with the classification of countries into either developed, emerging or frontier economies. But what exactly are these classifications based on? How often are they reviewed as economies and financial systems mature? And do index providers always agree on the way a country is classified?

With millions—or even billions—of dollars anchored to these international equity indices, understanding the answers to questions like these is critical for investors of linked ETFs. Each index provider has its own criteria, and in some cases, differences in opinion that can have a tangible effect on performance of ETFs that seem similar on the surface.

The majority of the largest international equity ETFs are benchmarked to indices from two separate index providers: MSCI and FTSE Russell.


Many popular international equity ETFs, including those from iShares are benchmarked to indices from the MSCI. Some of the largest include the iShares Core MSCI EAFE ETF (IEFA) and the iShares MSCI Emerging Markets ETF (EEM).

MSCI reviews and classifies countries on an annual basis, with the most recent review having been released in June. Within each review, MSCI provides a detailed assessment of market accessibility for each country that is included within the indexes.

Specifically, MSCI looks at 18 distinct measurements across five criteria: openness to foreign ownership, ease of capital flows, efficiency of the operational framework, availability of investment instruments, and stability of the institutional framework.

The resulting output is that countries are classified as developed, emerging, frontier or stand-alone markets. Stand-alone markets are not included within either the MSCI Emerging Markets Index or MSCI Frontier Markets Index. However, these markets do use similar methodological criteria for size and liquidity.

The most recent classification as of June 2021 is shown below:


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Courtesy of MSCI

(For a larger view, click on the image above)


Over the past 15 years, MSCI has usually reclassified one or two countries per year. MSCI only considers markets for upgrade if the change in the classification status is viewed as irreversible.

As a result, countries are most often “upgraded” as their financial systems mature. But in some circumstances, they can also be downgraded in periods of instability or crisis.

MSCI downgraded Greece from a developed to emerging market in June 2013, making it the first developed nation to receive a downgrade from the index provider. MSCI’s rationale centered on several of the criteria such as securities borrowing and lending facilities, short selling and transferability.

In the years prior to this downgrade, Greece had faced a sovereign debt crisis in the aftermath of the “Great Recession” and resulting global fallout. Greece received several bailouts from the International Monetary Fund in exchange for Prime Minister Papandreou’s commitment to austerity measures.

Most recently, MSCI announced the reclassification of Pakistan due to size and liquidity concerns, moving the country from an emerging market to a frontier market. The change was announced in September 2021 and implemented across the affected indexes as of the close of Nov. 30, 2021 during the semiannual index review.

FTSE Russell

Vanguard chooses to benchmark its international equity ETFs to indices from FTSE Russell. For example, the largest international ETF by AUM, the Vanguard FTSE Developed Markets ETF (VEA), is benchmarked to the FTSE Developed All Cap ex US Index.

Vanguard also has the largest emerging markets ETF, the Vanguard FTSE Emerging Markets ETF (VWO), which stands at $82.7 billion. This fund tracks the FTSE Emerging Markets All Cap China A Inclusion Index.

Similar to MSCI, FTSE Russell conducts an annual review of all markets contained in its global benchmarks, which is published in September, as well as an interim update that’s published in March.

FTSE Russell uses six main criteria: World Bank GNI Per Capita rating; creditworthiness; market and regulatory environment; foreign exchange market; equity market; and clearing, settlement and custody.

The most recent classification as of September 2021 is shown below:


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Courtesy of FTSE Russell

(For a larger view, click on the image above)


With the exception of Romania, all of the countries FTSE Russell classifies as an emerging market are also classified as such by MSCI. Romania is considered to be a frontier market by MSCI.

However, FTSE Russell gets slightly more granular than MSCI, classifying developing countries as either advanced emerging or secondary emerging.

For a country to be classified as an advanced emerging economy, international investors must have greater ease of access and protection that has not yet been established in secondary emerging countries.

FTSE Russell’s goal with having a two-tier system to categorize emerging markets is to give investors a view on how much progress a country has made on the path to being a developed market, as differences between various emerging market economies can be quite large.

The index provider also keeps countries on the watch list for a minimum of a year prior to a change in classification. Watch list candidates must demonstrate they are making progress toward criteria to be maintained on the watch list.

However, Joti Rana, head of Governance and Policy, Americas at FTSE Russell, notes that “maintaining a market on the Watch List for an overly long period is unhelpful to both the candidate market and global investors.”

In other words, watch list candidates are those that are soon expected to meet the criteria for upgrade and are showing “sufficient momentum” in their progress to meet these goals.

Notable Differences

While there are a few differences in classifications between MSCI and FTSE Russell, the largest portfolio impact centers around South Korea. The country is classified as an emerging market by MSCI and a developed market by FTSE Russell.


Courtesy of FactSet


This difference means that South Korea shows up as a top country allocation in VEA but is missing from the iShares Core MSCI International Developed Markets ETF (IDEV), with the remaining countries receiving a slightly higher weighting.


Courtesy of FactSet


In a year like 2021, where South Korea markets sold off and exhibited weak performance relative to international equities as a whole, ETFs that track a developed market FTSE Russell index can underperform those that are benchmarked to a developed markets index from MSCI.



The other side of the coin concerns differences in emerging market ETFs. Here, the difference is even more substantial. South Korea shows up as nearly 13% of EEM but is excluded from VWO.


Courtesy of FactSet


South Korea’s exclusion means VWO has higher weightings to other emerging market economies.


Courtesy of FactSet


In contrast to 2021, the year prior was one of strength for South Korea equities. The iShares MSCI South Korea ETF (EWY) gained 39.4% for the year. This gave EEM a slight edge, outperforming VWO by 1.9% over calendar year 2020.



While it seems likely MSCI will upgrade the country to a developed market eventually, the most recent Global Market Accessibility Review from the provider hints that this is not likely to happen any time soon.

As a COVID-19-related measure, South Korea banned short selling, and has since only partially lifted the ban for securities included in the KOSPI 200 and KOSDAQ 150 indexes.

MSCI notes that this means the country will experience a deterioration in the rating for the short selling criterion, as there is currently no timeline for resumption of short selling for remaining securities.

Due Diligence Required

Both MSCI and FTSE Russell have detailed and clearly outlined criteria supporting their classification systems, and neither is right or wrong. And while these differences in construction and performance might seem small on an absolute level, there is the possibility of tangible impact for investors.

This is especially true when you consider a portfolio’s potential allocation to a core international equity fund such as VEA or IDEV. Aggressive portfolios could see an allocation to these funds at 30% or higher, depending on advisor and client preference.

When it comes to international equity ETFs, country classification and how it differs from one index provider to another is one more data point to consider within the investment selection process.

As always, doing the due diligence to look beyond the name and understand what is inside of an ETF is a vital part of building an intelligently designed portfolio.

Contact Jessica Ferringer at [email protected] and follow her on Twitter

Jessica Ferringer, CFA, is a writer and analyst for etf.com. She has 10 years of experience in investment research and due diligence, including helping to manage ETF portfolios. Jessica has a bachelor’s degree in economics from Lafayette College and an MBA from the University of Pittsburgh.