Published in partnership with Northern Trust Asset Management.
Korea belongs to the 38-strong OECD grouping of advanced economies. The liberal democracy is the world’s 12th largest economy, making it bigger than Australia’s. The ‘Miracle on the Han River’, as it’s known for how it recovered from the civil war of 1950-53, is stable, boasts thriving export and manufacturing sectors, has a credible central bank, and offers a standard of living to match that of Spain and Portugal. Korea is home to innovative companies such as Hyundai Motor, LG Electronics and Samsung Electronics (and global influencing K-brands and K-pop groups).
Koreans have achieved inventions across electronics (watch phone), appliances (digital refrigerator), information technology (first country to adopt 5G), robotics (cancer-fighting nanobot), entertainment (cinema LED screen), and the internet (eSports).
Yet MSCI classes Korea, like Taiwan, as an “emerging market”, along with the likes of Israel, Italy, Portugal, China, Greece and Mexico.
On June 23, MSCI released its annual assessment of Korea that once again reaffirmed its emerging-market status due to nine market-access hurdles for foreigners. A big obstacle is how the won only trades during the Korean day. Other barriers are a ban reimposed last year on short-selling stocks, sub-par corporate-governance and limits on foreign ownership in aviation, broadcasting, telecommunications and utilities.
Seoul wants Korea included in MSCI developed indices so it’s pushing to extend won trading to London’s business day. And one day, no doubt, the country will be promoted.
What’s interesting is the world’s two other big index-service providers, namely FTSE Russell and S&P Dow Jones Indices, already classify Asia’s fourth-largest economy as a developed market. Such are the divergences between the trio that cater for investors interested in emerging markets.
As the table below shows, these structural divergences have a direct bearing on returns for investors who choose to track an index – and it also means that a decision to choose one index over another amounts to an active decision, even for a passive investor.
US$ returns of FTSE Russell, MSCI and S&P emerging-market indices to 31 May 2024
| One year | Three years | Five years | |
| FTSE Russell | 15.1 | -11.8 | 25.3 |
| MSCI | 12.4 | -6.2 | 3.6 |
| S&P Dow Jones | 16.0 | -3.7 | 4.8 |
Sources: FTSE Russell, MSCI and S&P Dow Jones factsheets for May 2024
The EM sauce
The index-service providers are transparent in how they classify countries from developed to emerging to ‘frontier’. The methodologies have changed (improved) over time where many changes were driven by quirks such as stocks listing outside their home country (Chinese company American deposit receipts), the increased sophistication of data analytics, and growing client requests for bespoke indices.
“As an index provider, our goal is to provide solutions,” Wanming Du, Director, Index Policy, APAC at FTSE Russell, told Investment Magazine. “If an asset owner says we are looking for an emerging-market index ex-China because China is so big, we have that solution. We don’t make the decision. We provide the benchmark.”
While the three index service-providers offer similar emerging-market benchmarks in that Taiwan Semiconductor Manufacturing was the largest stock and China was the biggest country on May 31, the returns of their indices vary over all time periods. The index providers are probably best judged on this metric.
While creating the best-performing index for the US share market can be about being the first index provider to include rising stars such as Alphabet, Apple, Google and Meta when they were still small, the key decisions around an emerging-market index is which countries to include, and how to provide exposure to a segment of the market.
The different treatment of Korea and China ‘A-shares’ explain much of the divergence of performance of the trio’s indices. In 2019, to cite how one provider handled the A-shares decision, MSCI decided to lift the weighting of these shares in the MSCI Indexes from 5 per cent to 20 per cent in three steps.
Different ways
MSCI, the provider of choice for Australian emerging-market managers, first offered an emerging-market index in 1988. (The index factsheet reports on a net total-return variant incepted in 2001.) At the start, Argentina, Brazil, Chile, Greece, Jordan, Malaysia, Mexico, the Philippines, Portugal and Thailand were selected as the countries worthy of investment. At the time, these 10 markets represented 1 per cent of world stock-market capitalisation. The countries were chosen on MSCI’s key criteria of the cost of investment, a country’s risks, the freedom of capital movements, and a country’s openness to foreign ownership.
The index now includes 24 countries of which seven are originals (Brazil, Chile, Greece, Mexico, Malaysia, the Philippines and Thailand). Over the 36 years, 26 countries have been added to the index (Pakistan twice). The last country welcomed was Kuwait in 2020. Of note, Korea was included in 1992, while China first entered in 1996, when Shanghai- and Shenzhen-listed ‘B shares’ were included, but more comprehensively in 2017 when the coverage was extended to China A shares.
Twelve countries have left. Some such as Israel in 2010 were promoted to developed status, while others were expelled. Last booted was Russia after the invasion of Ukraine in 2022 when the country was classified as a ‘stand-alone’ market. The benchmark, which comprises nearly 1,400 stocks, now represents about 11 per cent of world stock-market capitalisation.
MSCI offers an emerging markets ‘Horizon’ index that tracks the equity performance of the smallest 25 per cent of countries – Brazil, China and India are excluded. Others in the suite are ‘Small Cap’ and ‘ESG Focus’ index offerings. About US$1.3 trillion is benchmarked worldwide to MSCI emerging-market indices.
On May 31, TSM was 8.6 per cent and China 27.2 per cent of the MSCI Emerging Market Index. One-, three- and five-year index performance in US dollars to end May was 12.4 per cent, minus 6.2 per cent and 3.6 per cent respectively.
FTSE Russell, which has US$15.9 trillion worldwide benchmarked to its equity and bond indices, launched its emerging-market index in 2006. After nine additions and nine exclusions, most recently Russia in 2022, the FTSE Russell Emerging Market Index contains 24 countries, as it did on launch.
The FTSE methodology, which slots markets into developed, ‘advanced emerging’, ‘secondary emerging’ and frontier categories, looks at market eligibility and development status across 22 criteria in four broad areas. These areas are market and regulatory environment, foreign exchange, the equity market, and clearing, custody and settlement.
Watch lists
Country responses on the criteria allow FTSE Russell to balance the local view of the equity market against the view of staff and independent experts. To ensure transparency, FTSE Russell publishes a watch list of markets that might be reclassified.
At the end of May, TSM was 8.7 per cent and China 29.6 per cent of the FTSE Russell Emerging Markets Index. One-, three- and five-year index performance in US dollars to the end of May was 15.1 per cent, minus 11.8 per cent and 25.3 per cent respectively.
S&P Dow Jones Indices has offered the S&P Emerging Broad Market Index since 31 December 1997 when it included 37 countries. The company uses quantitative criteria complemented with qualitative indicators and the views of global investors to classify markets. As of May, S&P Dow Jones Indices labelled 25 countries developed, 23 emerging, 32 frontier and nine (including Russia since 2022) as standalone.
The quantitative criteria cover macroeconomic requisites, political stability, market size and liquidity conditions, market accessibility and related investment processes. To promote transparency, S&P Dow Jones Indices publishes an annual watch list of countries that could be reclassified.
On May 31, TSM was the largest stock in the S&P Emerging BMI but no weighting was given, while China stood at 28.4 per cent. One-, three- and five-year index performance in US dollars to the end of May was 16.0 per cent, minus 3.7 per cent and 4.8 per cent respectively.
Selecting the right benchmark and tracking the toing and froing within this index are essential tasks for emerging-market managers. Morningstar data for the 25 or so emerging-market funds offered in Australia show all use MSCI as their benchmark. If past performance is any guide, investment managers might help their clients if they switched to the FTSE Russell or the S&P alternatives.
To be sure, there are many similarities between the trio’s indices. But the way they have evolved over time means there are enough differences too. While no fund manager would make a mistake in choosing any of the three, issues such as the classification of Korea do matter when it comes to performance – and the choice of index is effectively an active decision, for any investor.
