While Korea again failed to join the Morgan Stanley Capital International (MSCI) developed market index over won trading issues, it is exerting enormous influence on products tracking the emerging market index. As Samsung Electronics (005930.KS) and SK hynix (000660.KS) have recently shown steep share price gains, the weightings of these two stocks effectively determine the results of MSCI emerging market index products. On the back of strong semiconductor earnings, global investment banks (IBs) have also raised their outlook on the Korean economy.
Wall Street's Flagship MSCI Emerging Market ETF Posts 40% Return in One Year on 'Samsung-hynix' Effect
Bloomberg reported Sunday that the returns of the flagship emerging market exchange-traded funds (ETFs) run by the world's largest asset managers, BlackRock and Vanguard, have widened significantly due to the recent surge in Korean stocks. According to the report, BlackRock's 'iShares Core MSCI Emerging Markets ETF (IEMG)' recorded a return of about 40% over one year as of June 30. In contrast, Vanguard's competing product, the 'FTSE Emerging Markets ETF (VWO),' posted a return of about 20% over the same period, roughly half. These are ultra-large ETFs with assets under management of 150 billion dollars and 120 billion dollars, respectively.
Bloomberg analyzed that the returns of these two products, which had previously moved in similar patterns, recently diverged unusually. It diagnosed that whether Korea's market was included effectively determined the difference in returns.
BlackRock's IEMG tracks the MSCI emerging market index and includes stocks such as Samsung Electronics and SK (034730.KS) hynix. Within IEMG, Korean stocks account for about 23%, the second-highest weighting after Taiwan (27%). By contrast, Vanguard's VWO tracks the emerging market index of Britain's Financial Times Stock Exchange (FTSE) Russell and thus cannot invest in Korean stocks. FTSE Russell has classified Korea as a developed market since 2009, excluding it from the emerging market index. VWO has relatively higher weightings in the Chinese and Indian markets instead of Korea. Bloomberg found that, along with the Korean market, whether ultra-large listed companies such as SpaceX were included also affected the return gap between the derivative products.
It is not only recently that Korea's Samsung Electronics and SK hynix have led the returns of emerging market index products. On June 21, Bloomberg also assessed that Korean semiconductor companies such as Samsung Electronics and SK hynix rebounded not only their share prices but the total profits of emerging market index companies for the first time in four years. According to Bloomberg data, the weighted average earnings per share (EPS) of MSCI emerging market index companies recorded 95.1 points on a trailing 12-month basis through May this year, exceeding the year-earlier forecast for the first time since April 2022.
Bloomberg diagnosed this as the effect of Samsung Electronics and SK hynix's first-quarter net profits exceeding market forecasts by 43% and 16%, respectively. Taiwan's foundry (contract semiconductor manufacturing) company TSMC also beat expectations by 5.7%, contributing to the overall profitability improvement of MSCI emerging market index companies.
Wall Street further believes that the MSCI emerging market index has room for additional gains based on earnings improvements. This is because, as of June 21, the 12-month forward price-to-earnings ratio (PER) of the U.S. semiconductor equipment index was more than 46 times, while the MSCI emerging market information technology (IT) index was only 12.3 times. In effect, earnings growth is faster than in the U.S., while prices are only about 26% of the level.
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Korea previously failed again to join the MSCI developed market index on June 23. The reason Korea, which shows the traits of a developed country in every respect, cannot shed its developing-country status uniquely at MSCI is due to won conversion restrictions. MSCI, a global index compilation agency, operates indexes by classifying stock markets worldwide into developed, emerging, frontier, and standalone markets. Currently, the developed market index includes 23 countries such as the U.S., Japan, and Britain, while the emerging market index includes Korea, China, and India. Korea was included in the emerging market index in 1992. Sixteen years later, in 2008, it was first placed on the watch list for developed market index inclusion. But from 2014, it was also removed from the watch list, citing difficulties in won conversion and restrictions on the use of exchange data.
MSCI, the global index compilation agency, did not place the Korean market on the developed market index watch list, citing among the reasons that won conversion in the offshore foreign exchange market remains limited. At the time, MSCI explained, "We acknowledge the measures announced by Korea's market authorities to address long-standing concerns," but added, "Investors responded that the fundamental issues have not been fully resolved." MSCI went on to stress, "The won cannot be physically delivered offshore," emphasizing that Korea's currency cannot be used when trading physical assets in the international foreign exchange market.
In reality, the won is currently traded offshore mainly through non-deliverable forwards (NDF) rather than physical delivery. NDFs are transactions settling only the difference in dollars. MSCI viewed that although won trading hours in the onshore foreign exchange market have been extended into the night, insufficient liquidity is constraining the operational flexibility of index fund managers.
Regarding the full resumption of short selling since March last year, MSCI also pointed out that market participants are bearing considerable burdens under the newly introduced market surveillance regulation framework. MSCI advised, "For consultation on a potential market reclassification to take place, all issues raised must be resolved, reforms must be fully implemented, and market participants must have sufficient time to fully assess the sustained effects of the changes."
Other Wall Street IBs have likewise begun to view Korea's economic level more favorably. According to the Korea Center for International Finance on July 7, eight major IBs—JPMorgan, Citibank, Barclays, Goldman Sachs, HSBC, Bank of America (BofA), Nomura, and UBS—presented an average forecast of 3.0% for Korea's real gross domestic product (GDP) growth rate this year through the end of June. That is up 0.2 percentage point in one month from 2.8% at the end of May. The IBs' forecasts continued to rise from an average of 2.0% at the end of last year to 2.1% at the end of January, 2.4% at the end of April, and 2.8% at the end of May. In particular, JPMorgan sharply raised Korea's real GDP growth rate from 3.0% at the end of May to 3.7% at the end of June. Citibank also lifted it from 3.0% to 3.5%. Britain's Capital Economics (CE) recently presented Korea's growth forecast at 4.0% in a report.
Behind the shift in global IBs' views is, again, the memory semiconductor boom represented by Samsung Electronics and SK hynix. These eight IBs also presented Korea's current account surplus ratio to GDP at an average of 14.0%, a full 3.2% higher than 10.8% in May. Compared with the 6.5% forecast at the end of December last year, it is more than double.
Wall Street expects that returns on products tracking the emerging market index will remain strong for the time being, buoyed by the high-flying performance of Samsung Electronics and SK hynix. This is evidence that the influence of Samsung Electronics and SK hynix in major global markets is growing stronger. Wall Street is also paying keen attention to Samsung Electronics' second-quarter earnings on July 7 and SK hynix's listing of American depositary receipts (ADR) on the Nasdaq market on July 10. However, the excessive concentration in artificial intelligence (AI) semiconductor stocks, including these two, in the emerging market index remains a source of unease for investment.
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