Could South Korea And Taiwan Graduate To Developed Market Status?

The debate over what countries are developed or emerging markets could be stoked again this month as MSCI, the index provider and firm responsible for market classification, commences its annual reclassification review. As Barron's notes, South Korea and Taiwan are two emerging markets that are “on the bubble” for a potential promotion to developed market status. South Korea has been down this road several times in the past and to be sure, it is one of the steadier markets in an asset class loaded with volatile members. Barron's correctly points out the potential for unwanted taxable distributions to investors in the iShares MSCI Emerging Markets Index Fund EEM and the Vanguard Emerging Markets ETF VWO if South Korea and/or Taiwan are moved to developed market status. Both countries combine for about 26% of EEM and VWO's respective weights and iShares and Vanguard would need to sell South Korean and/or Taiwanese equities to be inline with the index's new composition, leading to cash distributions. Since Uncle Sam can tax that distribution, that's not great news, but even more importantly, investors need to be concerned about the impact of graduation to developed market status for the iShares MSCI South Korea Index Fund EWY and the iShares MSCI Taiwan Index Fund EWT. There is a case study: Almost exactly two years ago, Israel moved from emerging to developed status. The country had a major weight in the MSCI emerging markets index, but is a bit player in the developed market index. The same fate could befall South Korea or Taiwan. While the iShares MSCI Israel Investable Market Index Fund EIS has climbed more than 30% since Israel's promotion to developed market, that performance lags VWO, EWY, EWT and the SPDR S&P 500 Trust SPY, in some cases, by very wide margins. Being a developed market isn't all its cracked to be, at least not when it comes to ETFs.