Developed Markets vs. Emerging Markets
When you hear on the news that 'emerging markets were shaken,' don't you wonder just where 'emerging' ends and who decides that? And what's different about investing in developed versus emerging markets?
Who divides them, and by what criteria
The ones that divide countries into 'developed' and 'emerging' are index providers like MSCI, FTSE, and S&P. They evaluate each country's market every year and assign a grade.
In MSCI's case, it looks at three broad criteria. (1) Level of economic development (used mainly for the developed-market determination) (2) Investability (whether the market size and liquidity are sufficient) (3) Market accessibility (whether foreigners can freely buy and sell, and whether currency exchange and settlement are smooth)
In other words, the key yardstick is not simply 'is it a rich country' but 'is the market developed enough for foreign investors to invest comfortably.' So even a country with a large economy may not be classified as developed if its market accessibility is low.
Why does Korea differ from body to body
An interesting case is Korea. It's the same country, but the classification differs from body to body.
MSCI still classifies Korea as 'emerging,' while FTSE classifies Korea as 'developed.' The reason they diverge is that the criteria each body emphasizes (especially foreign market accessibility, ease of currency trading, etc.) differ slightly.
This clearly shows that 'a classification is not an absolute truth.' Depending on which index you follow, the same country can go into an emerging-market index or a developed-market index.
So when investing in an 'emerging-market fund' or a 'developed-market fund,' it's good to check which body's classification that product follows.
Classifications aren't fixed and can change. When market reforms are carried out, a country may be promoted from emerging to developed, or conversely demoted.
The investment-perspective difference: growth expectations vs. volatility
Developed and emerging markets differ in investment character.
Developed markets (the U.S., Europe, Japan, etc.) are generally mature and relatively stable. In return, since they've already grown, the expectation of explosive growth is relatively smaller.
Emerging markets (India, Brazil, Southeast Asia, etc.) are seen as having large growth potential, but they carry that much more volatility and many risk factors. Three are representative. (1) Exchange-rate risk — emerging-market currencies swing sharply, so your won-converted gain can lurch. (2) Capital-flow risk — in a global crisis, foreign money tends to flow out first, so the drawdown often deepens. (3) Political/policy risk — institutions can change abruptly.
To sum up, there's a trade-off: 'emerging markets have bigger growth expectations, bigger volatility.' You can't say which side is better; it's important to understand it according to your own risk tolerance.
Preguntas frecuentes
Q. If emerging markets have large growth potential, isn't it advantageous to pile into them?
Large growth potential means large volatility and risk too. Emerging markets fall more sharply in a global crisis, and with the exchange rate piled on top, your won losses can grow large. Rather than piling into one side, diversifying between developed and emerging is a common way to reduce risk. That said, this article doesn't recommend a particular allocation.
Q. If Korea is MSCI emerging, is that a loss for Korean investors?
Rather than a matter of loss or gain, it's a matter of 'which index basket you go into.' There's an expectation that more related money would flow in upon promotion to developed status, but promotion itself doesn't guarantee returns. Understand a classification as merely a label that indicates market characteristics.
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