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Is it time to re-draw the EM categories

MSCI’s recent decision to remove South Korea and Taiwan from its review list and exclude China’s A-shares from its EM index raises a few questions about how we should be thinking about emerging markets.


 The reasons provided for this were largely technical in nature and were similar to those used to remove South Korea and Taiwan from consideration for inclusion in the group´s developed market index.

But, while there is a distinct method to MSCI´s decision on both counts, given the changing nature of the global economy, one cannot help but think there might be a little madness in it as well.

Starting with China, while it is fair to say it is well represented within MSCI´s emerging markets index, that its A-class shares, those listed on the country´s Shanghai stock exchange, are not yet included seems a little odd.

Indeed, that the world´s second largest economy (whose double digit growth over the course of the last decade has been the main source of fuel for the world’s economic engine) is still only vying for a place within the index-maker´s second tier seems a little odd too.

Ahead of the developed

As for the developed markets, South Korea and Taiwan, with high savings rates and current account surpluses, are arguably in a stronger position than parts of peripheral Europe from a sovereign risk point of view, but they too don’t tick all of MSCI’s capital adequacy and liquidity boxes. And, thus, are currently not in contention for a place among the world´s developed markets.

MSCI has valid reasons for its decisions from an index point of view, based as they are on very strict criteria.

In order to classify as a developed market, a country needs to have:

  • Country GNI per capita 25% above the World Bank high income threshold for three consecutive years
  • Five companies with a full market capitalisation of $2519m, a float market capitalisation of $1,260mm and security liquidity of 20% of annualisede traded value ratio (ATVR)
  • Very high levels of openness to foreign ownership
  • Very high capital mobility
  • Very efficient operational framework
  • Very high levels institutional framework stability.

These criteria, it says, drive the “composition of the investment opportunity sets to be represented” within its indices. And, for the purposes of index construction, such criteria are important. But, when one is looking at the increasingly disparate countries lumped together as emerging markets, a stronger case can be made for a more nuanced approach.


Is there merit perhaps in a category that slots in between the existing developed markets and emerging markets? A second division, if you will, made up of submerged developed markets and emerged EMs. Or would such a category look like little more than the index equivalent of a participation medal for those countries that couldn’t quite make it through the qualifying rounds?

The popularity and the endurance of the BRICs moniker, flawed as it is, gives an indication of the demand from investors for ever-better ways to understand and characterise the long term development of the global economy. But, would a new categorisation be of any real use, or would it ultimately suffer the same problems as the BRICs one has?

According to Remy Briand, MSCI managing director and head of index research, MSCI has not heard any desire expressed from investors for further segmentation.
“If anything, there seems a growing desire to be able to invest globally,” he said.

Asked the same question, Franklin Templeton’s emerging markets specialist and manager of the group’s Emerging Markets Investment Trust, Mark Mobius, said that he too felt a new category was unnecessary.

“There are already a plethora of indices making life difficult for investors who are often confused as to the meaning of each. We do not subscribe to following indices but rely on in-depth company research.”

There is no question that the range of choices available to investors is overwhelming, not only are there new ways to invest but new markets are being opened up to smaller investors – in large part because of index tracking funds, most based on the work done by MSCI.

Level playing field

But, unlike Mobius, most investors don’t have a 90-person research team at their disposal, nor do they have his decades of experience in the area.

For most investors, the MSCI classifications are the lens through which emerging markets are viewed. And, like any lens, it is only useful if it is fit for purpose.

There is no doubt that the technical criteria used by the index provider have a role to play in determining the risk and accessibility of markets for investors. But, equally, it is important to recognise that names have a power all of their own.

While it has been around for a long time, the phrase ’emerging market’ still has a whiff of the exotic to it that conjures up expectations of both risk and reward. Increasingly, however, the EM moniker is home to very disparate groups of countries, and viewing them all as equally risky, or rewarding is only going to end badly from an investment point of view.

Depending on one’s definition, there are reasons not to let them all into the developed world index just yet, but classifying a country like South Korea, or China as ’emerging’ seems a little crude.

And, for investors’ struggling not only to find yield but to come to grips with a ever-more-fluid investment landscape, such an overly broad categorisation seems like far too blunt an instrument to be of much use.