MSCI’s Emerging Market Index Decision (EEM, VWO)
One view is ETFs linked to the MSCI Index (NYSE:EEM) (iShares Emerging Market ETF) and (NYSE:VWO) (Vanguard Emerging Market ETF) are hugely popular, and when market conditions have been bullish overall, both ETFs have exhibited superior performance.
(NYSE:EEM) has roughly $35 billion in assets while (NYSE:VWO) has $37 billion. (This doesn’t even include ETFs trading overseas also linked to the same index.)
South Korea (13.2%) and Taiwan (11%) account for nearly 25% of index weightings making them important drivers as to index and ETF performance.
Another view is neither should be viewed as emerging markets since they more properly belong in the developed market category. The competing FTSE Group has moved both to the developed market category.
Why would the FTSE Group do this? The market caps of South Korea and Taiwan dwarf (nearly double) those of current developed markets like Greece and Israel. Much the same can be said of comparable GDP data.
MSCI cited technical factors in their decision including a lack of an active off-shore market for its currency and what they viewed as various anti-competitive factors. This reasoning seems weak since aforementioned GDP and market cap data should be more powerful factors.
If MSCI were to remove them it would be disruptive to existing ETFs. However, if they were moved, they most likely would wind-up in the EAFE Index (MSCI Europe Australasia and the Far East). What country markets would replace them if changes occurred? That’s an interesting question. Perhaps more countries from the ASEAN-China Free Trade Area (ACFTA) would be added, or more Latin American markets and/or current constituent allocations would increase in weight. Further, EAFE would have to change as country sectors would move up (“frontier” markets) or down (Greece) from different areas.
No matter how you cut it, emerging market ETFs have been performance leaders in rising markets versus developed markets due to higher economic growth and superior demographics. EEM and VWO are already market leaders and the MSCI decision will (if economic growth continues in the Asian region) cause this leadership to continue.
Standing pat means index linked ETFs will continue to perform in a superior fashion when market conditions overall are rising.
So what’s important for investors to remember from all this?
Investors should understand what they own may not coincide with what they assume. Nevertheless, sometimes “out of sight, out of mind” is the better route to performance even when the index doesn’t jive with investor intuition.
Dave Fry is founder and publisher of ETF Digest and best selling book author of Create Your Own ETF Hedge Fund, A DIY Strategy for Private Wealth Management published by Wiley Finance in 2008.
Disclaimer: No positions in EEM or VWO.