What makes an "Emerging" market

[the_wiki]

I am trying to talk to one of my kids about portfolio building and they were asking me why Emerging Markets funds seemed to contain some of the biggest economies in the world. What is "emerging" about a 19 Trillion GDP in China or a 2 trillion GDP in Brazil? Why is Poland in Developed markets but Taiwan is emerging? Is there specific criteria? Or are they just still in buckets we put them in back in 1980?

[gtwhitegold]

I would suggest that you read FTSE's public notes on their index updates if available. A lot of index changes use qualitative and quantitative methods, so even though Qatar has one of the highest GDP per capita in the world, it's still listed as emerging due to qualitative measurements such as access to healthcare or income inequality. With FTSE upgrading Poland, their previous unwillingness to downgrade any of the western European countries after the Global Financial Crisis, and their reluctance to upgrade Taiwan to a developed market status leads me to believe that they do have a significant western bias in their review process.

Similarly could be said about MSCI with their exclusion of Korea and Taiwan from their developed markets index.

[nisiprius]

It has to do with the maturity of the market and the degree to which it is integrated into the global economy. For example, the IMF says

There is no official definition of an emerging market. The IMF World Economic Outlook classifies 39 economies as “advanced,” based on such factors as high per capita income, exports of diversified goods and services, and greater integration into the global financial system. The remaining countries are classified as “emerging market and developing” economies.

There are specific criteria:

We derive a score for each economy not considered advanced, using five weighted variables:

0.40×nominal GDP+
0.15×population+
0.15 ×GDP per capita+
0.15×share of world trade+
0.15×share of world external debt

If a country is ranked in the top 20 for 2010–20, it receives a score of 1 for that variable. Otherwise, it is assigned zero. The final score is calculated as the weighted sum of the individual scores. This approach identifies the following countries in the emerging market group, in alphabetical order: Argentina, Brazil, Chile, China, Colombia, Egypt, Hungary, India, Indonesia, Iran, Malaysia, Mexico, the Philippines, Poland, Russia, Saudi Arabia, South Africa, Thailand, Turkey, and the United Arab Emirates. Two countries were excluded: Nigeria because of its classification as a low-income country (eligible for IMF Poverty Reduction and Growth Trust financing) during the sample period considered (2010–20) and Qatar because of its population of less than 5 million.

You may agree with that or not, but it isn't just a matter of subjective judgement or "just still [keeping them] in buckets we put them in back in 1980."

Different authorities use different criteria and come up with different lists.

GDP is a red herring, and is often used to sell emerging markets as attractive investments. However, "rapid growing economy" does not imply "rapid growing stock."

[burritoLover]

FTSE classifications

[the_wiki]

Thanks for the replies. It appears it has more to do with how developed their stock market and trading regulations are and not how developed their economy is. Good information.

[secondopinion]

I would suggest that you read FTSE's public notes on their index updates if available. A lot of index changes use qualitative and quantitative methods, so even though Qatar has one of the highest GDP per capita in the world, it's still listed as emerging due to qualitative measurements such as access to healthcare or income inequality. With FTSE upgrading Poland, their previous unwillingness to downgrade any of the western European countries after the Global Financial Crisis, and their reluctance to upgrade Taiwan to a developed market status leads me to believe that they do have a significant western bias in their review process.

Similarly could be said about MSCI with their exclusion of Korea and Taiwan from their developed markets index.

Technically, South Africa scores better than Taiwan and Korea according to the MSCI market accessibility review for 2022. Poland is not considered a developed market to them, and Hong Kong and Singapore are considered developed markets.

It is not just about whether the economy seems or even is advanced, the public capital markets actually have to be developed. No one would argue that Iceland and Burkina Faso have different standards of living (more than 50 times higher GDP per capita for Iceland, and Iceland is close to the US itself in this metric), but they are both classified as "frontier markets" because their markets are not developed fully.

https://www.msci.com/documents/1296102/ ... essibility.

[gtwhitegold]

I would suggest that you read FTSE's public notes on their index updates if available. A lot of index changes use qualitative and quantitative methods, so even though Qatar has one of the highest GDP per capita in the world, it's still listed as emerging due to qualitative measurements such as access to healthcare or income inequality. With FTSE upgrading Poland, their previous unwillingness to downgrade any of the western European countries after the Global Financial Crisis, and their reluctance to upgrade Taiwan to a developed market status leads me to believe that they do have a significant western bias in their review process.

Similarly could be said about MSCI with their exclusion of Korea and Taiwan from their developed markets index.

Technically, South Africa scores better than Taiwan and Korea according to the MSCI market accessibility review for 2022. Poland is not considered a developed market to them, and Hong Kong and Singapore are considered developed markets.

It is not just about whether the economy seems or even is advanced, the public capital markets actually have to be developed. No one would argue that Iceland and Burkina Faso have different standards of living (more than 50 times higher GDP per capita for Iceland, and Iceland is close to the US itself in this metric), but they are both classified as "frontier markets" because their markets are not developed fully.

https://www.msci.com/documents/1296102/ ... essibility.

I didn't know that about South Africa, but I haven't been tracking FTSE'S or MSCI's index updates for quite some time. I also don't know what you are specifically trying to address with this post. My point in the previous post was that different index providers have different methods for determining who belongs in what category i.e. developed, emerging, or frontier, and after quantitative methods are used, there are frequently still qualitative determinations made by human beings for which countries are included in a specific category and if they are included in an index at all.

As nisiprius mentioned earlier, the IMF has their own standard which seems to be more quantitative than qualitative, and may be a good metric to base the decision off of, but no fund follows the country guidance provided by the IMF, they normally will either generate their own or follow something provided by an index provider like FTSE or MSCI.

[tetractys]

Sound like emerging markets are markets still at risk of submerging.

[secondopinion]

I would suggest that you read FTSE's public notes on their index updates if available. A lot of index changes use qualitative and quantitative methods, so even though Qatar has one of the highest GDP per capita in the world, it's still listed as emerging due to qualitative measurements such as access to healthcare or income inequality. With FTSE upgrading Poland, their previous unwillingness to downgrade any of the western European countries after the Global Financial Crisis, and their reluctance to upgrade Taiwan to a developed market status leads me to believe that they do have a significant western bias in their review process.

Similarly could be said about MSCI with their exclusion of Korea and Taiwan from their developed markets index.

Technically, South Africa scores better than Taiwan and Korea according to the MSCI market accessibility review for 2022. Poland is not considered a developed market to them, and Hong Kong and Singapore are considered developed markets.

It is not just about whether the economy seems or even is advanced, the public capital markets actually have to be developed. No one would argue that Iceland and Burkina Faso have different standards of living (more than 50 times higher GDP per capita for Iceland, and Iceland is close to the US itself in this metric), but they are both classified as "frontier markets" because their markets are not developed fully.

https://www.msci.com/documents/1296102/ ... essibility.

I didn't know that about South Africa, but I haven't been tracking FTSE'S or MSCI's index updates for quite some time. I also don't know what you are specifically trying to address with this post. My point in the previous post was that different index providers have different methods for determining who belongs in what category i.e. developed, emerging, or frontier, and after quantitative methods are used, there are frequently still qualitative determinations made by human beings for which countries are included in a specific category and if they are included in an index at all.

As nisiprius mentioned earlier, the IMF has their own standard which seems to be more quantitative than qualitative, and may be a good metric to base the decision off of, but no fund follows the country guidance provided by the IMF, they normally will either generate their own or follow something provided by an index provider like FTSE or MSCI.

The point is mostly about the point that classification relies quite a bit on the development of the country's capital market. Iceland looks good according to the IMF and it has a good economy (albeit very small), but some of the features generally found in a stock market are not present (stock lending, shorting). In point of view of an investor, Iceland would be subject to considerable pricing risks due to their limited currency exchanges and the lack of shorting. A good economy, but would a foreign investor find this a safe market to invest in? Probably not.

[Valuethinker]

FTSE classifications

Am I missing South Korea in those lists?

It's hard for me not to consider South Korea as a developed market. The same would go for Taiwan (which is very clearly an Emerging Market in most definitions).

[alex_686]

Am I missing South Korea in those lists?

It's hard for me not to consider South Korea as a developed market. The same would go for Taiwan (which is very clearly an Emerging Market in most definitions).

South Korea is under advanced. Look under the “S”s, not the “K”s.

[patrick]

FTSE (whose indexes are used by Vanguard international funds) include the World Bank Atlas GNI (fairly similar to GDP) as a requirement to enter the developed category. However, they use the per capita value rather than the total. By that standard China and Brazil are not high enough:

7740 Brazil
11880 China
13205 Minimum required
16850 Poland

Sources:

https://research.ftserussell.com/produc ... _Paper.pdf
https://blogs.worldbank.org/opendata/ne ... -2022-2023

[patrick]

I would suggest that you read FTSE's public notes on their index updates if available. A lot of index changes use qualitative and quantitative methods, so even though Qatar has one of the highest GDP per capita in the world, it's still listed as emerging due to qualitative measurements such as access to healthcare or income inequality. With FTSE upgrading Poland, their previous unwillingness to downgrade any of the western European countries after the Global Financial Crisis, and their reluctance to upgrade Taiwan to a developed market status leads me to believe that they do have a significant western bias in their review process.

FTSE has published plenty of information on their criteria on https://www.ftserussell.com/equity-coun ... sification including ratings of each country in each category. Healthcare and income inequality are not included. Rather, they didn't classify Qatar as developed due to concerns regarding derivatives, clearing, custody, and settlement.

FTSE (and MSCI) did downgrade Greece which is not exactly western in a geographical sense but is a long-time NATO and EU member. As the name suggests, the global financial crisis was widespread and thus downgrading countries simply because they were hit by it would mean no country remaining developed.

My point in the previous post was that different index providers have different methods for determining who belongs in what category i.e. developed, emerging, or frontier, and after quantitative methods are used, there are frequently still qualitative determinations made by human beings for which countries are included in a specific category and if they are included in an index at all.

MSCI publications on https://www.msci.com/our-solutions/inde ... sification show very similar criteria and ratings. With the sole exception of South Korea, MSCI and FTSE assign the same category to every country with significant market capitalization. If you use a total international index fund (which includes both developed and emerging) then South Korea is included either way, leaving no significant difference in which countries are included.

[Charles Joseph]

Investopedia has a really nice explanation of emerging markets. I love that site. You might find this helpful as an explanatory tool.

https://www.investopedia.com/terms/e/em ... conomy.asp

[Valuethinker]

Investopedia has a really nice explanation of emerging markets. I love that site. You might find this helpful as an explanatory tool.

https://www.investopedia.com/terms/e/em ... conomy.asp

Be careful with Investopedia and always cross-check.

I have found some articles which were actually in error.