MSCI Upgrade Unwanted as Emerging Beats Developed: Korea Markets

Jun 03, 2014 4:15 am ET

June 3 (Bloomberg) -- For South Korean stocks, it’s better to be a big emerging market than a small developed one.

Instead of welcoming a potential upgrade to developed status by MSCI Inc., money managers prefer Korean shares to remain in the MSCI Emerging Markets Index because they’ll attract more money as the second-largest component, said BNP Paribas Investment Partners. The nation’s stocks beat the emerging index by about 11 percentage points in the past five years, while trailing the advanced-nation gauge by 41 points as of yesterday.

MSCI, whose indexes are used by investors with $8 trillion to measure performance, will say in its annual classification review on June 10 whether Korea has done enough to free up its currency and ease investor regulations, two conditions for an upgrade. Shinyoung Asset Management, KTB Asset Management Co. and Mirae Asset Global Investments predict the country will remain an emerging market for at least another year.

“It would be better to be at the head of emerging markets than becoming the tail of the developed world,” Huh Nam Kwon, the chief investment officer at Shinyoung, which oversees about $8.8 billion, said in an interview in Seoul on May 26.

Investor sentiment toward emerging-market stocks is improving after more than three years of underperformance versus their developed-nation counterparts. The MSCI emerging markets index has climbed 9.8 percent since mid-March, more than twice as much as the MSCI World Index. U.S. exchange-traded funds that invest in developing nations have lured about $8.7 billion of inflows during the period.

Flows Outlook

The MSCI Korea Index rose 0.6 percent at the close in Seoul, while the MSCI Emerging Markets index increased 0.4 percent.

For Korea, “staying an emerging market is better for flows at the moment,” said Arthur Kwong, the Hong Kong-based head of Asia Pacific equities at BNP Paribas Investment Partners, which manages about $650 billion.

Korean shares comprise about 16 percent of the MSCI emerging gauge, the second-highest weighting among 21 countries after China’s 19 percent, data compiled by Bloomberg show. That compares with 11 percent for Brazil and 7 percent for India.

If it were included in the MSCI World index of advanced- nation shares, Korea would take up a smaller proportion, said Kim Chul Min, a money manager at Mirae Asset Global Investments in Seoul. The nation’s $1.3 trillion market capitalization is about 5 percent of America’s $23 trillion market. It’s also smaller than that of Japan, the U.K., Hong Hong, Canada, France, Germany, Australia and Switzerland.

Israel Example

In the four years since Israel was upgraded to developed- market status from emerging, MSCI’s gauge for the country has lost about 6.7 percent. It trailed the MSCI World Index by 84 percentage points and lagged behind the emerging-market measure by about 30 points.

“You might attract a different type of investor, but even if they get promoted to developed status, the proportion may be smaller,” said Nicholas Yeo, a Hong Kong-based money manager at Aberdeen Asset Management Plc, which oversees about $541 billion worldwide.

MSCI has been consulting with investors on whether to categorize South Korea as a developed market since 2008. While the country has met most of the index provider’s criteria, including economic development and liquidity, MSCI said in last year’s classification review that the limited convertibility of the won in offshore currency markets and a rigid investor identification system prevented an upgrade.

Taiwan, China

The index provider is also considering an upgrade of Taiwan to developed-market status, along with the inclusion of China’s mainland-traded shares in the MSCI Emerging Markets index.

MSCI declined to comment on its market classifications before next week’s announcement, saying the information is “price sensitive,” Chin-Ping Chia, the Hong Kong-based head of research for MSCI in Asia, said by e-mail.

Korea Exchange is aware of concerns raised by MSCI, though the bourse hasn’t seen “much improvement” compared to last year, Kim Ki Kyung, team manager of the Kospi market trading rule and regulation division, said by phone on May 30.

The MSCI Korea index has slipped 0.4 percent this year, versus a 0.5 percent drop in the benchmark Kospi index through yesterday. The MSCI gauge is valued at 1.04 times net assets, compared with 1.5 for the emerging-market index and 2.2 for the MSCI World.

The won has strengthened 3.1 percent against the dollar this year, while the yield on benchmark three-year bonds has dropped eight basis points to 2.83 percent.

Bigger Pool

An upgrade to developed-market status by MSCI would expose Korea’s biggest companies to a wider pool of investor money and provide a potential boost to the nation’s technology and auto exporters, said Lee Jae Hun, a Seoul-based analyst at Mirae Asset Securities Co. About $2.3 trillion is benchmarked against the MSCI World index, versus $1.3 trillion for the emerging- market gauge.

Samsung Electronics Co., the world’s biggest smartphone maker and Korea’s biggest company by market value, trades at about 7 times reported earnings. That compares with a multiple of 20 for the MSCI World Information Technology Index, data compiled by Bloomberg show.

“Those companies, such as Samsung Electronics, will gain an edge over global peers since they are much cheaper,” Lee said.

Two of MSCI’s competitors, FTSE and S&P Dow Jones Indices, already classify South Korea as a developed market.

“Most of the people we talk to feel it’s a developed market,” David Blitzer, chairman of the S&P index committee, said in a phone interview from New York on May 29. “They don’t report any unusual issues about currency convertibility and about investing.”

FTSE Upgrade

Investors who specialize in developing nations would prefer Korea to remain an emerging market because it gives them more scope to diversify holdings away from other large peers such as China, said Ryan Tsai, an Asia equity strategist at Standard Chartered Plc in Hong Kong.

In 2012, Vanguard Group Inc.’s decision to drop Korean stocks from its emerging-market exchange-traded fund spurred the ETF’s biggest outflows on record compared with BlackRock Inc.’s competing fund, which still includes the country.

The Kospi index has lagged behind the MSCI World index and the FTSE Developed Index by more than 40 percentage points since FTSE’s upgrade of Korea to developed-market status took effect in September 2009.

“We all wanted it in the beginning,” Lee Jin Woo, a money manager at KTB Asset Management in Seoul, which oversees about $7.2 billion, said by phone on May 29. “But I think we kind of found out later, in the case of the FTSE upgrade, that being labeled developed isn’t always so positive in supply and demand.”

--With assistance from Jiyeun Lee and Eunkyung Seo in Seoul.