Thoughts on the New World Order: Israel as a Developed Market, S. Korea as an 'Almost'

By Heather Bell

Country classification has gotten really interesting in the past couple of years with the rising interest in emerging and frontier markets. But that's probably just my inner unrepentant nerd talking.

Right now, in the wake of MSCI’s reclassification of Israel as a developed market, I’m working on a rundown of the country classifications of four major index providers: MSCI, Dow Jones, FTSE and Standard & Poor’s.

The evolution of emerging markets (and sometimes devolution of developed markets—see Greece, which could lose developed-market status in the FTSE indexes) is just particularly fascinating to me. Take some of the frontier/emerging markets that the index providers cover at the very bottom rungs of the investability ladder: Latvia? Slovakia? Trinidad & Tobago? Mauritius?

Frankly, I’m dying to know what the investment stories are behind these tiny, tiny markets. And while I believe frontier markets (like, say, Vietnam) offer some awesome investment opportunities, is anyone really itching to sink some funds into an obscure eastern European country that probably has a smaller population than the number of visitors to my local mall on the day after Christmas?

I realize there are different rules and methodologies that each of the index providers use, but it all seems rather mysterious. For example, Dow Jones—which generally uses the International Monetary Fund’s designations—classifies Slovenia as a developed market, while MSCI has it labeled as a frontier market. That’s quite a disparity.

Lately, the majority of the focus has been on Israel and South Korea, though, and whether they will transition to developed-market status within the various classification systems. MSCI, of course, just promoted Israel to developed status last week, while keeping Korea in the emerging category. Given that the majority of internationally invested funds are benchmarked to MSCI indexes (at least in the U.S.), this issue has been followed fairly closely by investors. At the end of March, Israel was the ninth-largest country in the MSCI Emerging Markets Index, with a 4.0% weighting, and South Korea was the fourth-largest, with a 12.4% weighting.

Given the amount of money benchmarked to that index and the even greater amount benchmarked to the MSCI EAFE Index, which Israel now joins, that’s an awful lot of funds shifting around. South Korea is up for reconsideration in 2010 (as is Taiwan, another country straddling the emerging/developed divide).

But MSCI seems to be on the tail end of the trend: Dow Jones, S&P and FTSE all classify South Korea as a developed market, while only Dow Jones and FTSE put Israel into the developed bucket. S&P still has Israel as emerging. Of course, FTSE, S&P and Dow Jones have a lot fewer funds tracking or measured against their global indexes.

They can shift their country classifications with relative ease, as they deem appropriate, without a lot of reverberation. But if MSCI decides to promote a country to developed status, many, many billions of dollars are going to be moving around, with all sorts of economic consequences.

And not all of them will be positive: In Israel, there is concern that the country moving from relatively big-dog status in the emerging markets index to a minor position in the developed markets index will actually result in outflows from the local stock market.

(Read an article on the latest MSCI moves here. Also of interest might be a Bloomberg article on the subject here, and another article from an Israeli publication about a Deutsche Bank study on the potential negative impacts of the switch.)

Teva Pharmaceutical (TEVA), Israel’s largest company, saw its price spike in June shortly before the official MSCI announcement, but there’s no telling what the longer-term effects will be. It will be interesting to see what happens with that, and even more interesting to compare the outcomes with what happens when South Korea—and its big stock, Samsung Electronics (SSNLF.PK)—is finally promoted to developed status.

Yeah, that was definitely the unrepentant nerd talking…

Original post

Comments

[ETF Grind:]

Slovenia is a bona fide part of the Eurozone, and should be considered a developed country. Someone is clearly on crack there.

S&P at least has South Korea right. How can a country richer than New Zelanad with a giant consumer finance sector and a consumption based economy be considered developing?

Jun 24 11:15 AM

[donzelion:]

S&P defines their criteria as follows:

"A country is classified as emerging if it has a low- or middle income economy as defined by the World Bank. In addition, the country’s investable market capitalization must be low relative to its most recent GDP figures and its equity market must exhibit substantial features of emerging markets." (from their Emerging Market Index factsheet)

On income, the World Bank rankings show Israel with an income of $22k, South Korea at $19k, down from Greece/Spain in the low $30k range (as of '08). Cyprus beats both of them, so maybe Cyprus ought to be classified as "developed"...

But the criterion "the equity market must exhibit substantial features of emerging markets" seems to mean "emerging markets are whatever we feel act like emerging markets." A self-referential definition, giving significant to name any country however they wish.

Still, it makes sense to resist changes until a country "obviously" changes from emerging to developed. If the indexes shifted too much, their utility as indicators would degrade.

Jun 24 01:53 PM

[rocco69:]

Invest in Israel? You got to be kidding. A better strategy, as well as a moral one, would be to divest from Israel and join the boycott Israel campaign.

Jun 24 02:05 PM

[FRR:]

Really Rocco? Do you use a GPS in your car? You know that mini camera pill developed to save lives? What about fertility treatments for childless couples? There are thousands of technology, medical, defense, and scientific breakthroughs developed in Israel. Many of which you probably use every day. It is unfortunate that Israel doesn't get the proper credit or recognition it deserves because of an ignorant, bigoted world that feels the need to pander to the petromoguls. Get an education!






















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On Jun 24 02:05 PM rocco69 wrote:

> Invest in Israel? You got to be kidding. A better strategy, as well
> as a moral one, would be to divest from Israel and join the boycott
> Israel campaign.

Jun 24 04:23 PM

[ETF Grind:]

I would broadly agree. But having strict criteria has its downside.

The only reason why South Korea is being held up over at MSCI is that its "market information systems not fully competitive".

Meaning what? That because Bloomberg and Thompson Reuters hasn't set up shop yet its an "emerging economy"?

That's way too arbitrary.

On Jun 24 01:53 PM donzelion wrote:

> S&P defines their criteria as follows:
>
> "A country is classified as emerging if it has a low- or middle income
> economy as defined by the World Bank. In addition, the country’s
> investable market capitalization must be low relative to its most
> recent GDP figures and its equity market must exhibit substantial
> features of emerging markets." (from their Emerging Market Index
> factsheet)
>
> On income, the World Bank rankings show Israel with an income of
> $22k, South Korea at $19k, down from Greece/Spain in the low $30k
> range (as of '08). Cyprus beats both of them, so maybe Cyprus ought
> to be classified as "developed"...
>
> But the criterion "the equity market must exhibit substantial features
> of emerging markets" seems to mean "emerging markets are whatever
> we feel act like emerging markets." A self-referential definition,
> giving significant to name any country however they wish.
>
> Still, it makes sense to resist changes until a country "obviously"
> changes from emerging to developed. If the indexes shifted too much,
> their utility as indicators would degrade.

Jun 24 05:21 PM

[cameroni:]

Are you kidding me Rocco! Israel is a very, very good investment. You seem to be among the crowd that lets politics cloud their judgement of investing opportunities and that is an expensive mistake to make. And on that point, if morality is your barometer for investment opportunities you had better stick to something easy.

Like gardening.


On Jun 24 02:05 PM rocco69 wrote:

> Invest in Israel? You got to be kidding. A better strategy, as
> well as a moral one, would be to divest from Israel and join the
> boycott Israel campaign.

Jun 24 08:04 PM

[Mad Hedge F...:]

I think South Korea has been neglected. With North Korea testing low grade nukes and short range missiles (think WWII German V2’s), and a former prime minister jumping off a cliff to commit suicide, you wouldn’t think this is the best time to contemplate an investment in South Korea. You may recall that I recommended that the Hermit Kingdom be added to spell “BRICK” with a “K” last January (www.madhedgefundtrader...) .
Korea is in fact somewhere in between a true emerging market and a developed country, with lower risk and lower returns, than say a Taiwan or an India. Let’s see how that call faired. After hitting a low of 998 in March, it soared 45% to a seven month high. The recent troubles have pared it back by 10%. For long term investors, this is opening a rare window to scale into some exposure here. Short term traders should wait for a bigger pull back. They used to say you bought Asia only when there was blood in the streets. This isn’t really blood, but is close enough.

Jun 25 09:09 AM

[donzelion:]

"Meaning what? That because Bloomberg and Thompson Reuters hasn't set up shop yet its an "emerging economy"?"

You'll find both Bloomberg and Reuters bureaus in Saudi Arabia (which isn't on anyone's list of candidates for inclusion as "developed"). Guess we'd have to look elsewhere to try to figure out a non-arbitrary basis for the distinction.

For S. Korea, their chaebols have significantly less accounting or shareholder oversight than a comparable Japanese keiretsu or American/European conglomerate (as S. Korean banks discovered in the Asian collapse of '98.

For Israel, politics aside, the $3 billion in US aid each year does distinguish their economy from others. While only 1.5% of GDP, the US package is distinct from the $2 billion to Egypt (which predominantly operates as a U.S. export subsidy), or the EU subsidy programs (similar effect, distinct mechanics) in that Israel can subtly leverage its aid package so that it has far-reaching economic impact. (Note: this shouldn't imply anything at all with respect to the suitability of any specific investment in Israel, only a remarkable distinction from developed economies.)

Jun 25 02:20 PM

[Uday Maitra:]

From a hedge fund perspective, we use an important criteria (among others) often overlooked: shorting allowed along with liquid lending/borrowing markets. although it is a narrow criteria, i think it serves us better to look at the characteristics of the market or its micro-structure, rather than the GDP - because the GDP can make many EU countries look developing and China a developed country.

South Korea, not among the best as far shorting mechanism, but reasonably good enough, better market structure than countries like Spain, Italy etc - so for us definitely developed. No doubt Israel has great companies like Teva, but not sure about the lending/borrowing mechanism and currently it seems like only naked shorting is prevalent (i might be wrong) - hard to argue that can be called developed - most likely it might be better off classified as developing. Another similar example: India - shorting legally allowed, but non-functioning lending/borrowing while shorting is mostly done by single stock futures which is often inefficient with basis risks and rollover costs - hence definitely developing. China - no shorting, and hence developing, but Hong Kong is on par with western infrastructure and therefore developed. South Africa on the other had has much lending/borrowing than say India or China and a better candidate to put in the same category as developed countries in spite of its GDPs and economic numbers.

Jun 25 05:41 PM