Working toward a more definite EM classification scheme

An index specialist explains efforts to go beyond the narrow economic criterion that historical definitions depend on

Working toward a more definite EM classification scheme

For many investors that seek emerging-market (EM) access, using investment vehicles based on EM indexes is one easy way to get diversified exposure. But given how many developing economies have grown and changed since their initial classification, one may question whether some EM benchmarks still deserve the label.

That’s the problem addressed by Tim Batho, senior index policy strategist at FTSE Russell, in a new blog post. He noted that some professional investors gauge their EM exposure based on a variety of measures pertaining to the current and likely future performance of EM as a sector, or of countries within it.

“[F]or index providers and many other market participants, assessing whether a country is developed, emerging, or frontier, based on these pure economic measures is not the sole, or even main, consideration,” Batho said.

He noted how the International Finance Corporation of the World Bank first used “emerging market economy” in the early ‘80s to identify a country with low to middle per capita income — which most readers would recognize today as a relatively narrow definition. The liberal use of the term “emerging market” is evident, he continued, based on the huge variation in economic size and complexity seen among countries that fall within the category.

In response to feedback raised by FTSE Russell’s advisory committees, Batho said the firm decided to define EMs “primarily from an investment, regulatory, operational and market accessibility perspective and, specifically, from the position of an international investor.” Aside from World Bank GNI per capita, it considers 21 relevant objective criteria across four segments:

  • Regulation;
  • Custody and settlement;
  • Dealing landscape; and
  • Derivatives

Following these considerations, FTSE Russell classifies equity markets around the world into Developed, Advanced Emerging, Secondary Emerging, and Frontier markets. “The framework seeks to recognize a broader array of criteria that has greater relevance to the majority of the investment community,” Batho said.

Countries classified as emerging within the firm’s classification scheme form a relatively eclectic set of markets from an economic perspective. As of March 2019, Advanced Emerging markets included Brazil, Greece, Hungary, Mexico, South Africa, and Taiwan, among others; the Secondary Emerging umbrella, meanwhile, covers Chile, China, India, Indonesia, Pakistan, the Philippines, Qatar, and Russia, along with other several other nations.

“But all these countries have to meet the same nine criteria within the Country Classification framework,” Batho said, noting the importance of considering the implementation timescale and process. While smaller markets may be added in a single tranche, larger markets typically have to be incorporated in multiple tranches to limit disruption to global markets.

“Ultimately, it is still for the asset owners and their investment advisors to determine whether the balance of risk and return inherent within any market classified as emerging fulfills the requirements of their investment strategies,” he stressed.


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