ETF Plays On The Next Developed Markets

by on June 8, 2010 | ETFs Mentioned:

Before it attracted intense scrutiny from the international community for its ongoing blockade of Gaza, Israel had made headlines last month for a relatively rare economic achievement. The country was recently upgraded from an emerging market to a developed market by index provider MSCI Barra, meaning that Israeli equities were cast out of the MSCI Emerging Markets Index and into the MSCI EAFE Index. Israel became the first country to graduate to developed status (in the eyes of MSCI at least) since Greece in 2001.

While somewhat uncommon, upward movements to developed status are not unprecedented; many of the world’s advanced economies were once tabbed with “emerging” status, including Japan. It’s worth noting that while an upgrade to developed status is undoubtedly a major accomplishment, the impact on equity markets can be adverse. When Israel’s promotion was made announced, stocks promptly plummeted. That’s because investors anticipated a net selling of Israeli equities from index funds and ETFs; the allocation in developed market funds was expected to be considerably smaller than the weightings previously afforded in emerging market benchmarks.

Next Up: South Korea

Although the world’s economies are generally lumped into one of three primary categories (with “frontier” being the third), they are in reality spread across a spectrum, with some much closer to developed status than others. So which are the next markets to make the leap from “emerging” to “developed”?

The smart money is on South Korea, a country many investors expected to be upgraded along with Israel. In the press release declaring Israel’s upgrade, MSCI noted that “Korea meets the economic development as well as the size and liquidity requirements” for developed status. But preventing a graduation from the emerging markets benchmark were the lack of full convertibility of the Korean Won and the fact that stock market real-time data is subject to contractual anti-competitive clauses. In other words, Korea is a developed market from an economic perspective, but issues related to the ability to exchange its currency and dissemination of market data have left it lingering in “emerging” status.

There are currently two South Korea ETFs, each of which offers very unique exposure:

  • iShares MSCI Korea Index Fund (EWY): This ETF tracks the MSCI Korea Index, a benchmark that includes the largest and most liquid stocks listed on South Korean exchanges. Reflective of the South Korean economy, EWY features a tilt towards the technology sector.

Taiwan: Up Next?

Another good bet to follow in the footsteps of Israel is Taiwan, a country that also meets the economic development and size and liquidity thresholds for developed status. Last year, MSCI noted that there had “been several positive market reform measures over the past months” in Taiwan, and slated it for review this year. Major areas of concern include the convertibility of the New Taiwan dollar and restrictions associated with the Foreign Institutional Investors (FINI) ID system–relatively minor hurdles compared to achieving sufficient literacy rates, per capita GDP, and quality of life indicators.

There are also two ETFs offering exposure to Taiwan’s equity market–once again a large cap-heavy fund from iShares and a small cap focused product from IndexIQ:

  • iShares MSCI Taiwan Index Fund (EWT)
  • IQ Taiwan Small Cap ETF (TWON)

“Pure Play” Emerging Markets ETF

Although the economic profiles of Korea and Taiwan more similar to the U.S. and Western Europe than the BRIC bloc, most of the largest emerging markets ETFs give a significant allocation to these countries; they account for about 25% of EEM and VWO, which have more than $50 billion in aggregate assets. But not all the funds in the Emerging Markets ETFdb Category give big weightings to these quasi-developed nations; Emerging Global Advisors offers a number of ETFs linked to Dow Jones indexes that avoid Taiwan and Korea altogether, focusing instead on BRIC countries. These ETFs include a broad-based composite fund as well as three sector-specific options:

  • Emerging Markets Titans Composite (EEG)
  • Emerging Markets Metals & Mining Titans (EMT)
  • Emerging Markets Energy Titans (EEO)
  • Emerging Markets Financial Titans (EFN)

Disclosure: No positions at time of writing.