Telling Emerging Markets (EM) and Developed Markets (DM) apart may seem difficult, subjective and possibly confusing. We find vast differences within each category, never mind between them. To help cut through the clutter, we think South Korea’s bid to shift its status with index provider MSCI from EM to DM shows the divide between the classifications isn’t so cut and dry. Fisher Investments UK’s review shows how investors can navigate this fuzziness and benefit by finding opportunities arising from an indistinct border.
Fisher Investments UK knows that the MSCI, whose indexes are often used as measuring sticks for portfolio relative performance and sector/country diversification across the industry, bases EM and DM classification on countries’ economic development, equity market size, liquidity and foreign investors’ market access.[1] Many EM countries have lower income per capita and have economies more reliant on agriculture or commodities, versus services-orientated ones in DM.[2]
Meanwhile, constituent companies must meet MSCI’s “minimum investability requirements.”[3] Fisher Investments UK notes that, although the exact thresholds may change from year to year, DM feature bigger size and greater liquidity criteria for their companies and markets.[4] Then for investor accessibility, DM require “very high” market openness to foreign ownership, ease of capital inflows and outflows, operational efficiency and institutional stability (rule of law), alongside “unrestricted” availability of investment instruments.[5] These thresholds are lower for EM.[6]
Given South Korea’s advanced manufacturing capabilities and several of its corporations’ household name recognition – and market share – worldwide, we think it is hard to argue its economy isn’t competitive with many Developed Markets globally.[7] Based on gross domestic product (GDP, a government measure of economic output) per capita, South Korea ranks above DM countries like the UK and Japan.[8] Note: that doesn’t necessarily mean its GDP is faster growing. We often hear many suggest Emerging Markets, perhaps due to the name, means quicker GDP growth. But that often isn’t true according to our research. Rather, it is a level of competitiveness that truly matters. Similarly, South Korean markets’ size and liquidity are on par with many DM, too.[9] In these respects, Fisher Investments UK reviews find South Korea has more in common with advanced economies with well-developed financial markets than emerging economies.
But in June 2022, MSCI denied South Korea inclusion into its DM index on market accessibility grounds.[10] The index provider’s main reasons: the lack of an offshore currency market – allowing foreign investors to conveniently trade its currency, the won – and ongoing short-selling restrictions.[11] (Selling short means borrowing shares from a bank, selling them and later buying them back to close out the transaction. It is an investment tactic one might make if they forecast a stock declining, as the profit would be the gap between the sale price and the later, ideally lower, repurchase.)[12]
Fisher Investments UK notices global investors often want to mitigate currency risk in their portfolios. Because South Korean securities are denominated in won, returns also include changes in exchange rates after conversion into home country currencies for investors abroad. But hedging foreign exchange exposure isn’t as easy to do in South Korea compared to DM – for example, the country has allowed only local financial institutions to participate in the won spot market.[13] Whilst the desire for long-term global investors to short stocks isn’t great, in our experience, it is also a normal DM feature and aids liquidity, market efficiency and price discovery.
This year, South Korea’s finance ministry and the Korea Exchange – the country’s sole securities exchange operator – have taken steps toward allowing both.[14] It isn’t clear to us yet whether that will be sufficient for MSCI. Even if MSCI acquiesced, though, it wouldn’t bestow DM status immediately – the provider would only add South Korea to a watch list for potential inclusion later.[15] Fisher Investments UK notes that being on the watch list doesn’t ensure anything, either: South Korea was on it before in 2008, but six years later, MSCI took the country off the list, citing the “absence of any significant improvements in key areas negatively affecting accessibility.”[16]
Whilst this has been a long-running saga, note that other index providers have exercised independent judgement – and arrived at a different decision than MSCI. S&P Global has classified South Korea as DM since 2001 and FTSE Russell since 2009.[17] To them, other factors – such as input from global investors – overrode market accessibility concerns. Fisher Investments UK thinks this shows how index classification is more opinion than natural law.
This highlights a way investors can dig deeper when crafting a global portfolio, in our view: they don’t have to be bound by convention in security selection. By being aware of index methodologies – and their qualitative grey areas – and making decisions on their desired criteria, investors can selectively broaden their universe to their advantage. Adhering to DM selections only could overlook opportunities afforded by a wider scope. In Fisher Investments UK’s reviews of index classifications, investors can better weigh alternatives by looking beyond nomenclature.
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This document constitutes the general views of Fisher Investments UK and should not be regarded as personalised investment or tax advice or a reflection of client performance. No assurances are made that Fisher Investments UK will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. Nothing herein is intended to be a recommendation or forecast of market conditions. Rather, it is intended to illustrate a point. Current and future markets may differ significantly from those illustrated here. In addition, no assurances are made regarding the accuracy of any assumptions made in any illustrations herein. Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square (NYSE:SQ), Canary Wharf, London, E14 5AX, United Kingdom. Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
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“MSCI Market Classification Framework,” Staff, MSCI, June 2022. Size refers to market capitalisation (a measure of company size calculated by multiplying shares outstanding and current share price) and liquidity means the ease in which a security can be converted into cash.
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Ibid.
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Ibid.
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Ibid.
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Ibid.
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Ibid.
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“Is South Korea Crowding Your Emerging Markets Allocation?” John Welling, S&P Global, 24/11/2020.
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Ibid.
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Ibid.
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“South Korea Fails to Make MSCI’s Watch List for Developed Market Status,” Chung Joo-won, Yonhap News Agency, 24/6/2022.
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“S.Korea Considers Expanded Won Trading in Bid for MSCI Developed Market Inclusion,” Cynthia Kim and Yena Park, Reuters, 24/1/2023. Accessed via Financial Post. “Short Selling Key for Korea’s Global Index Goal, Bourse CEO Says,” Youkyung Lee, Bloomberg, 16/3/2023. Accessed via Yahoo!
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“South Korea Eases Market Rules to Court Foreign Investors,” Song Jung-a, Financial Times, 18/1/2023. Accessed via Small Business News.
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Ibid.
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“Korea to Extend FX Trading Hours, Allow Offshore Firms’ Participation,” Staff, The Korea Times, 7/2/2023. “Korea Can Consider Lifting Short Selling Ban in 2023, Watchdog Says,” Youkyung Lee, Kyungji Cho and Rishaad Salamat, Bloomberg, 28/3/2023. Accessed via Yahoo!
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See note x.
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“S.Korea to Explore Currency Changes to Qualify for MSCI Advanced Market Index,” Staff, Reuters, 26/1/2016. Accessed via the Internet Archive.
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See note ii and “Classifying South Korea as a Developed Market,” Christopher Woods, FTSE, January 2013.