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South Korea: Developed or emerging?

Is South Korea developed or emerging? You can find indexes that classify it one way, and indexes that classify it the other. However, before choosing investment products based on one index or another, it is essential to understand how and why the index providers made their classification and what effect that has on the relevant indexes. They all use objective economic and market criteria to make their decisions, of course. But they still don’t all agree on the answer. And that has a big effect on the way different Emerging Market and Developed Market indexes behave.

Some leading index providers still classify South Korea as Emerging. The country has a weighting of 15% in the MSCI Emerging Market index (the second largest country weighting after China) which means this index will inevitably behave very differently from emerging market indexes created by, for example, FTSE which classifies South Korea as developed.

So why the big difference in classification? 

FTSE explained its position in some detail last year after Vanguard joined other large asset owners in adopting the FTSE emerging indexes. Much of the reason lies in the methodology each index provider uses to create their indexes. FTSE’s country classification methodology, for example, relies on external committees comprising experienced market practitioners, asset owners, institutional investors, and consultants who reflect their actual market experience in the advice they give to FTSE. Additionally, as long ago as 2004 FTSE introduced a set of principles to evaluate specific markets, increasing the objectivity and transparency of the process. These include criteria such as market regulation, custody and settlement; market size; liquidity; market access; and whether these factors are likely to remain stable over the long term.

Long term improvement in market quality may qualify a country for reclassification from emerging to developed. FTSE puts some countries potentially eligible for reclassification on a “Watch List”, and from time to time its Policy Group, with the advice of the external market experts, may decide to reclassify a country.

In 2009 it moved South Korea from emerging to developed in recognition of the country’s strong relative economic position in the world (see box). There were only three criteria on which South Korea did not fully qualify (total currency convertibility, delivery of some stock transfers, and trading in some foreign-owned stock) but FTSE believed its markets would soon address these issues.

In the event, the global financial crisis intervened to slow down the pace of improvement, so those criteria remain yet to be satisfied in South Korea. Yet FTSE still believes the country is correctly classified as a Developed Market. Country classification is not merely an exercise in box-ticking: it is a response to the way market practitioners actually view each market. FTSE’s practitioner-based methodology clearly indicates that the majority of market users no longer lump South Korea, with its advanced economy, in the same basket with the likes of China, India or Brazil. To include the country in an Emerging market index, therefore, would simply introduce unwanted distortions into the index’s behavior.

Which is why the classification of South Korea as Developed is so widely accepted in the investment universe as a whole. Leading indexers such as S&P accept this classification. And Jim O’Neill, the Goldman Sachs analyst who coined the term “BRICs”, was recently quoted as saying that regarding South Korea “as an emerging market is absolutely ridiculous.” Leading fund managers such as Fidelity, Schwab, Vanguard and JP Morgan offer investment products based on FTSE’s emerging markets index which, of course, does not include South Korea.

In the end, creating indexes is about finding the best way to reflect accurately how market professionals view the markets they use. FTSE believes the evidence overwhelmingly shows that practitioners consider South Korea to be a developed market. And that is ample justification to classify it as such in FTSE’s indexes.

South Korea’s strong economy:

  • the 15th largest economy measured by GDP, industrial output and services
  • the 12th largest economy in terms of purchasing power parity
  • the 7th largest exporter and 10th largest importer in the world
  • the world’s 13th largest stock market and the 3rd largest in the Pacific Rim (after Japan and Australia)
  • home to some of the world’s biggest and most successful corporations, such as Samsung and Hyundai Motors, and it is the world’s 4th largest car producer and worlds largest shipbuilder
  • has a thriving high-tech industry and a high-tech population, being the first country to achieve more than 50% internet broadband adoption among the population and is the most wired country on the planet in terms of internet use and speed
  • a member of the OECD, and the World Bank classifies South Korea as a high-income developed country with a developed market

The strength and size of its economy rank it among the G-20 major economies.

Source: The World Bank, The Economist

 

 

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