MSCI upgrade not wanted in Korea
'Change from emerging to developed status neither possible nor necessary'
By Cho Jin-seo
MSCI, a major provider of equity benchmark indices, will not upgrade South Korea’s stock market to “developed market” status from “emerging” in its third assessment next week, analysts said.
The grader is to announce the result of its annual reclassification of Korea and Taiwan on June 22. There used to be enthusiasm around this time in previous years but not anymore. Most analysts expect no change, and even if the promotion materializes, its effect won’t be big, they say.
“I don’t want your money!” is the headline of a report from Korea Investment & Securities published last week. The governments in Korea and other emerging nations, such as Qatar, do not welcome massive foreign investment in equities anymore because this often leads to volatility in the market, the report’s author Park So-yeon says.
“The capital does not pick emerging markets in Asia anymore. It is the market that picks which capital they like,” she says.
The diminishing interest in the MSCI’s categorization reflects the fact that the emerging market itself has grown so big and powerful that it is no longer dependent on money from investors in rich countries.
Moreover, emerging nations are no longer viewed as riskier than so-called developed nations. Morgan Stanley, which used to be a major shareholder of MSCI (which stands for Morgan Stanley Capital International) until 2009, says the distinction has become less significant.
“We do not expect any significant net inflows of funds into Korea given its relatively small weight in the Developed Index and (experiences) from previous inclusions. We also do not expect any significant re-rating story in Korea from the potential change given similar valuation levels for EM versus DM,” its report said on May 27.
The stock valuation of emerging and developed markets has narrowed to almost equivalence over the past years (see chart). The emerging markets’ price-earnings ratio, which shows how much listed company’s stocks are priced compared to their ability to make profit, was only around a half of that of the developed market in the early 2000s. But the ratio continued to surge as the emerging economies become more stable. Now it is around 0.9.
So an upgrade won’t surprise investors as they did before, says Shaun Cochran, Korea research head of CLSA, a brokerage. “This is a flow question so it will only drive prices in the short term.”
But there could be a rebalancing of foreigners’ portfolio by industry sector. Cochran says that the upgrade will be good for large-cap stocks and negative for mid and small-cap stocks. Park of Korea Investment & Securities thinks that telecom and finance stocks will benefit as their current valuation ratio is lower than the developed market average.
Inflow and outflow
Along with the FTSE index, the MSCI Developed Markets Index is a popular definition of developed — thus more stable — economies in the global market. Twenty-three nations in North America, Europe, Asia and Oceania belong to this group. Israel was added to the list in 2009.
Global investors, especially institutional investors such as pension and sovereign wealth funds, often follow this categorization when they want to put money into less risky equity markets. One of the most popular ways to do this is to buy an equity-traded fund (ETF) designed on the FTSE or MSCI index. This effectively allows investors to invest in the whole stock market of a particular country or of a particular group of countries.
A move from emerging to developed status brings not only benefits but also losses. There are many funds that prefer emerging markets where returns are generally higher. So when there is an upgrade, there is outflow as well as inflow.
“(If Korea joins the developed group), it will be a small fish in a big pond, while Korea is a big fish in a small pond in the emerging market,” said Sakthi Siva, an analyst at Credit Suisse, when Korea was excluded in last year’s MSCI promotion. And this year, the presence of Greece, Portugal and Ireland does not make the “big pond” look very attractive.
Things get even more complicated when there is more than one country involved in the reclassification. This time, the MSCI is weighing Korea and Taiwan on whether to promote them to developed from emerging countries, and Qatar and United Arab Emirates to emerging from “frontiers” category. When there are more countries in one group, each market will take a smaller stake in the short run because of the mechanical portfolio rebalancing of big institutional funds.
The best scenario for Korea is that it stays in the emerging group while Taiwan gets a move to a developed market, says Park of Korea Investment & Securities. In her calculation, this scenario will theoretically bring an inflow of $9.3 billion into Korean stock markets. The next best scenario is that only Korea gets the upgrade, in which case it will receive $6.4 billion thanks to an inflow of funds that prefer stable investments.
Clarification: Morgan Stanley's spokesperson in Korea said it no longer controls or owns a majority share in MSCI since 2009.