Henry M. Seggerman President International Investment Advisers

Everybody knows that a great deal of money follows the MSCI Developed Markets Index -- two or three trillion dollars.  This ensures the KOSPI will jump at least 10% -- and perhaps a lot more -- when Korea finally gets upgraded from an Emerging Market to a Developed Market.  The question is: why is this upgrade taking so long? 

Seven years ago, MSCI’s key Developed Market upgrade hurdle was sustainable “High Income” GNI per capita, which then hovered around $9,000.  Korea, still recovering from the 1997 currency crisis, was just below this hurdle.  But before long, Korea got above the “High Income” ranking convincingly, in 2001, 2002, and 2003, satisfying MSCI’s requirement, and sustaining its level. 

In August, 2004, about three weeks after the World Bank’s official announcement of final approved 2003 national per-capita GNIs, MSCI hurriedly disseminated a questionnaire to investment professionals worldwide.  This questionnaire did not ask if Korea should be upgraded; instead, it suggested strongly that MSCI was adding “geo-political risk” (read: North Korea) as a new hurdle which would bar South Korea from being upgraded to Developed Market status.  Geo-political risk had virtually never been mentioned by MSCI prior to this as a hurdle.  MSCI was moving the goalposts just to keep Korea out. 

Today, with the Yongbyon reactor 90% disabled, with the New York Philharmonic playing Pyongyang, with the Kaesong Industrial Park and Mount Keumkang still humming with activity, whatever geopolitical risk existed a few years ago has largely dissipated.  Thus, it must be time for MSCI to publish another document ruling out a Korea upgrade. 

So, a few weeks ago, MSCI came out with a new document with a brand-new hurdle never mentioned at any time in the past: fully convertible currency.  MSCI is now arguing that a fully convertible currency, which allows forex traders to buy and sell a country’s currency at will, should be considered as a hurdle for upgrading a country to a Developed Market.   

Never mind that currency trading is largely irrelevant to MSCI’s actual business focus, stock trading.  Never mind that, if you want to trade the Korean Won, you can do so easily by trading Non-Deliverable Forwards (NDFs).  No, MSCI’s new rule is if your currency is not fully convertible, you can just forget about that upgrade to Developed Market status.  Once again, MSCI is moving the goalposts for the sole purpose of keeping Korea out of its Developed Markets Index.   

Think about the Hong Kong Dollar Peg for one second, and you will realize how unfair and hypocritical MSCI is.  Say you’re an asset manager in Japan or Europe with assets indexed to MSCI’s Developed Markets Index.  OK, if that is the case, then you are obligated to invest in stocks listed on the Hang Seng Index in Hong Kong.  If the business of those companies is good, their stocks should go up.  However, they won’t go up all that much if the U.S. Dollar keeps falling, as this crushes the value of the Hong Kong Dollar relative to the Yen, Euro and other currencies.   

The Hong Kong Dollar Peg is extraordinarily inefficient, and damaging to all non-American investors who invest in Hong Kong stocks.  Does MSCI say anything about the Hong Kong Dollar Peg?  Of course not.  All they care about is keeping Korea out of the Developed Markets.  They have no concerns whatsoever about those well-mannered former English colonies Hong Kong, Singapore and New Zealand, already safely tucked away in their exclusive Developed club. 

What is continuously amazing to professional asset managers is how blind MSCI is to the many airtight, compelling truths proving Korea already is a Developed Market:

 LIQUIDITY – Serious professional asset managers require actively traded stock markets, and Korea has one.  Its stock market is the twelfth most liquid in the world, trading on average $7 billion each day.  The New Zealand stock exchange by comparison trades under $90 million per day. 

COMPANY SIZE -- Serious professional asset managers require world-class blue-chip companies, and Korea has them.  Korea has the top six shipbuilding, the top two memory chip, and the top two picture tube companies in the world -- as well as world’s #1 high-speed internet provider.  Korea is an industrial powerhouse, and its world-class companies rank amongst the best equity investments in the world.  

For inclusion in MSCI indices, companies must be above minimum levels in terms of Company Size, Security Size, and Security Liquidity.  Specifically, to qualify for inclusion, a company must have a market cap exceeding $2 billion and a free float exceeding $1 billion.  In the report issued a few weeks ago, MSCI revealed for the first time that for a country to be included in its Developed Markets Index, it must have at least five qualifying companies.  Korea has 85 qualifying companies.   

One thing is obvious in MSCI’s revelation of its requirement of five companies: it’s a number conveniently manufactured after the fact to justify the inclusion of miniscule markets like Austria, New Zealand, Greece and Portugal – each with but a thimbleful of serious companies – in its Developed Markets Index. 

FOREIGN OWNERSHIP -- Serious professional asset managers require stock markets which already have high levels of foreigners’ ownership, as it bespeaks an obvious faith on the part of other foreign investors in these markets.  In this regard, Korea is extremely attractive, as its stock markets are 32% owned by foreigners, higher than any MSCI Developed Market and higher than any country with equal or greater market capitalization, with many blue-chip companies 50-60% owned by foreigners.  This is an obvious big vote of confidence coming from the international investment community.  Korea scrapped virtually all foreign ownership limits ten years ago; under 1% of Korean companies have foreign ownership limits today, less than many Developed Markets. 

PERCEPTION – Serious professional asset managers require markets which are stable because the financial industry as a whole perceives them as mature (Developed) markets.  A few years ago FinanceAsia magazine conducted a poll which showed that 83% of respondents favored upgrading Korea to a Developed Market and 90% viewed Korea as more developed than Greece. 

A few years ago, MSCI itself stated that “investor perception …is very important to MSCI and will be carefully considered,” with regard to market upgrades.  MSCI knows full well that professional asset managers have viewed Korea as a Developed Market for many years.  So, when MSCI asserts that “investor perception is important,” they are lying.  The truth is that MSCI has no interest whatsoever in what anybody thinks about Korea. 

What is the next step?  --I suppose we could urge “Bulldozer” to make Korea’s currency fully convertible, to satisfy MSCI’s latest rule.  That he could probably accomplish in a five-minute phone call.  However, it’s unlikely to change MSCI’s no-Korea policy.  If it were to happen, MSCI would probably just move the goalposts once again and spit out another brand-new rule.  Maybe they should simplify the process next time and just say “We don’t allow in countries where they eat kimchi.” 

Some have theorized that the real reason MSCI won’t upgrade Korea is mercenary.  MSCI revenue comes from subscriptions paid by thousands of asset managers worldwide.  A subscription to MSCI Developed Markets data costs $43,000, but a subscription to both Developed and Emerging Markets data costs $75,000.  If Korea were to exit MSCI’s Emerging Markets platform, it is believed that many of the asset managers who subscribe to both Emerging and Developed would drop the Emerging Markets data subscription and subscribe only to Developed Markets data.  This would result in a big hit to MSCI’s revenue streams.  MSCI’s obsessive campaign to exclude Korea is so bizarre and irrational, it makes theories about their ulterior motives credible.