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The MSCI1 Emerging Markets Index covers the performance of 817 emerging market stocks across 21 emerging markets. The index covers 85% of each country’s free float adjusted market cap, meaning it takes into account only the publicly available shares, as opposed to the total issued shares. In emerging markets it is common for companies to have low free-float percentages (e.g., in Latin American values as low as 10-15% are observable) as many family owners own a large portion of the outstanding stock, making it unavailable to the general public. Naturally countries with larger more and developed stock markets have larger market capitalizations and larger free-float percentages, and therefore end up having the lion’s share of the index.
The chart above shows the concentration for the top 5 countries in the index. China, South Korea and Taiwan account for 44% of the index. Approximately 10% more is accounted by the remaining Asian countries: Malaysia, Indonesia, Thailand and Philippines. Latin America accounts for c. 20% (driven by Brazil) and Africa for less than 10%. The two main ETFs tracking this index, Vanguard’s Emerging Markets ETF (VMO) and iShares Emerging Markets ETF (EEM) suffer from the same bias.
MSCI states that it frequently revises the composition of the index based “extensive discussions with the investment community”, though South Korea is still part of the index despite it is considered an “advanced economy” by the IMF and CIA, a “high income economy” by the World Bank, and a “developed market” by Dow Jones, FTSE and S&P. Additionally, Taiwan is considered an advanced economy by the IMF. Coincidentally, South Korea and Taiwan make up over 26% of the index.
The graph below shows the share by country grouped by regions for VMO, which closely tracks the MSCI EM Index:
An investor interested in tracking emerging markets should be aware of this concentration and consider minimizing exposure to other Asian securities to reduce the portfolio’s geographical concentration risk. Furthermore, it may be prudent to hold Africa oriented ETFs (e.g., EZA, AFK) or Latin America oriented ETFs (e.g., ILF, GML, LBJ) to truly diversify geographically.
© 2013 Market Realist, Inc.