Following Beijing’s surprise announcement of a shift in its currency policy, investors scrambled on Monday to snap up assets deemed to benefit from the change while attempting to interpret the ultimate impact on the global economy. The focus on the yuan’s new-found flexibility distracted investors from an important announcement out of Switzerland, where index provider MSCI released the results of its 2010 Annual Market Classification Review.
MSCI constructs and maintains the benchmarks to which many popular exchange-traded products are linked, meaning that changes in classifications of national economies could spur a shake-up from ETFs and index funds. Last year Israel was upgraded from “emerging” to “developed” status, prompting Israeli equities to be dropped from the MSCI Emerging Markets Index and added to the MSCI EAFE Index, a relatively minor shake-up considering the size country’s economy.
This year’s review brought potential for a much bigger reshuffling, with promotions for both South Korea and Taiwan possible. In its 2009 review, MSCI noted that both countries met the “economic development as well as the size and liquidity requirements” but that issues such as a lack of full convertibility of currencies remained as hurdles to developed status. South Korea and Taiwan make up nearly 25% of MSCI’s Emerging Markets Index, the benchmark to which the iShares MSCI Emerging Markets Index Fund (EEM) and Vanguard Emerging Markets ETF (VWO) are linked.
But there were no promotions forthcoming when the announcement was made on Monday; Korea will remain as an emerging market–at least in the eyes of MSCI–for another year. “Korea continues to meet most developed markets criteria of the MSCI market classification framework, notably economic development, market size and liquidity and many aspects of the market operational framework are at the level of developed market standards,” said MSCI in a press release. “However not all criteria are met and international institutional investors continue to express concerns related to certain important accessibility issues for Korea.”
“Emerging” In Name Only
Taiwan also appeared to come close to an upgrade, but fell short. “Taiwan also meets many developed markets criteria, including economic development and market size and liquidity,” said the MSCI statement. So despite the fact that South Korea and Taiwan closely resemble the U.S. and western Europe in terms of per capita GDP, literacy rate, life expectancy, and HDI scores, these economies will continue to make up a significant chunk of many investors’ emerging markets exposure.
The universe of emerging markets is not uniform across various index providers. Dow Jones mirrors the classification decisions of the International Monetary Fund (IMF), and as such has included South Korea and Taiwan as developed economies for more than a decade. Emerging Global Advisors offers a suite of ETFs linked to Dow Jones emerging markets indexes, including the broad-based Composite Titans Index Fund (EEG).
Although market classification decisions have always been carefully monitored by officials in countries eligible for reassignment, the release of results have drawn increased attention in recent years from investors around the globe. With index funds and ETFs accounting for an increasingly large portion of assets, the composition of certain indexes can have a major impact on demand for certain securities. Some see the potential for the tail to begin wagging the dog; an upgrade of Korea or Taiwan could have sparked a selling spree as investors sought to front run index-based emerging markets products that would be forced to reconstitute their holdings in the future (see Ticking Time Bomb Under EEM).
Among the other classification decisions handed down:
- United Arab Emirates (UAE) will remain as a frontier market, to be considered for an upgrade to emerging status next year. “MSCI continues to be encouraged by the planned future enhancements by the Emirati regulator such as the potential increase of the foreign ownership limit levels imposed by Emirati companies,” read the official commentary on the decision.
- Qatar will also remain as a frontier market, with an upgrade possibly coming next year.
- MSCI indicated that Greek’s status was not in jeopardy in the wake of the country’s near-collapse, noting that “the current Greek sovereign debt crisis has had no impact on the equity market accessibility and investability.”
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Disclosure: No positions at time of writing.