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MSCI to review market classifications

An influential financial services firm launched a review this week into the way it classifies a foreign stock market as either emerging or developed, a move that could eventually trigger the reallocation of billions of dollars in global capital.

In a discussion paper released this week, MSCI Inc, a developer of widely followed international market indexes, asked clients to comment on changes that could make it easier for markets such as Israel and South Korea to be reclassified as developed. Both countries, it wrote, "have achieved significant advancements in their structure and openness to international investors."

MSCI, which counts 24 of the 25 largest asset managers in the world as clients, says it will report its conclusions by June. It would then be at least a year before any countries would be upgraded or downgraded, the company said.

More than US$3 trillion in investments are benchmarked against MSCI international indexes, according to the company.

Any changes to its indexes would almost certainly induce additional investments in markets newly classified as developed. Vanguard Group's US$16 billion Pacific Stock index mutual fund, for instance, aims to mirror MSCI's Pacific index, which includes only developed markets. In addition, pension funds and other institutional investors generally limit their exposure to emerging markets to a small percentage of assets.

"It does make a great deal of difference to the construction of portfolios that are approaching Asia Pacific," said Andrew Foster, acting chief investment officer of Matthews Asian Funds, a San Francisco-based mutual fund company.

The paper sought comments from institutional investors on its classification criteria. It asked, for instance, whether it continued to make sense to exclude countries with significant geopolitical risk or currency restrictions from the list of developed markets.

It's not immediately clear whether South Korean stocks would be helped or hurt by a change in the country's classification, said Frank Nielsen, MSCI executive director for indexes in the Americas.

"You would have index funds in the emerging markets space selling and you'd have index funds in the developed markets buying," he said. "So therefore it's impossible to forecast if there will be any particular direction of these movements."

South Korea and Israel comprise 14 percent and 2 percent respectively of the emerging markets index. Among other countries listed as emerging markets are Taiwan, China, Brazil and Russia. Asian developed markets include Japan, Singapore, Hong Kong and Australia.

MSCI Inc is a spin-off of Morgan Stanley, and was formerly called Morgan Stanley Capital International. The company, which went public in November, licenses its stock indexes to asset managers and mutual fund companies.
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