South Korea's one point eight trillion dollars stock market is one of the biggest in Asia. Korea is also home to more global conglomerates than Hong Kong think of giants like Samsung and Hyundai. The country has higher purchasing power than Japan or Spain, and yet by one influential measuring stick, Korea is still designated as an emerging market, not a developed one. That measuring stick is a market index. An index is a way of tracking how a market is performing.
Firms that create indexes select a number of, say company stocks that they believe are a good representation of a market, and then they track how those stocks perform together as a group. Two examples of indexes you might be familiar with the S and P five hundred and the Dow Jones Industrial Average. They group some of the biggest US companies, and they're often considered a bot barometer for the stock market overall. Influential indexes like the SMP five hundred are
closely watched by investment firms and fund managers. Those are the people often making decisions about the stocks in your pension or four to oh one k It's one way they figure out what stocks to buy and sell. So what does this all have to do with Korea? There are other kinds of indexes, and one of the most influential is provided by the investment research firm MSCI. It puts together indexes that try to take the temperature not
just the companies, but whole markets around the world. An MSCI list Korea in its Emerging Markets index that includes Brazil, China, and Mexico, among other developing economies. Korea, though, wants to be bumped up to msci's prestigious World Index of Developed Markets, where it would sit alongside the US, UK, Germany and other economic powers. We're talking about this now because MSI is expected to decide this month whether to give South
Korea what it wants. But Bloomberg reporters Yuk Young Lee and Soul and Henry Wren in London wondered would making that leave actually be worth it. I'm wes Kosova today, I'm the big tig Why South Korea is looking to go big? You can you start by just painting a picture for us of South Korea's economy.
So South Korea has right now Asia's fourth largest economist and it's economic growth for the past century has been astounding a story of fast economic growth is the envy of the lot of developing countries and emerging Marcus and it's one of the richest and it's m and by some standards, richer than its neighbors such as Japan. It has more purchasing power than Japan, for example, and the
country has a lot of developed market features. If you want to see how your Asian stocks did overnight, a lot of fund manager uses this Asian stock index developed by MSCI, and it's MSCI who decides which stocks goes to this index, which stocks get drapped from the index, and based on this decision, a lot of money moves in and out of certain stocks.
So it's really important.
I think we also want to show the breakdowns of this MSCI market classification that we're talking about today. So the biggest league, the so called the Big League is called the MSCI World Index, is consisting of twenty three developed markets, including the US, Canada, France, UK, Israel which joined in twenty ten. And there is this smaller league called Emerging Market Index, and this is where South Korea
belongs to. And the biggest member of this emerging market in dex is China, The next one is Taiwan, and then there's India and South Korea is the fourth largest member. There are the members such as the Philippines, Malaysia, Turkey, Mexico as well, and there is also even smaller pond called frontier market. There's the country like Kenya island that belongs to the frontier markets. This is how MSCI divided the world into.
In the frontier market, how do is that different from an emerging market?
So emerging markets have greater growth rates, but however, some frontier markets also seeing very fast booming economy as well. But eclomy sites tend to be a bit smaller, even smaller compared with developing ones and also developed ones, and according to MSCI standards, the frontier markets should also probably have less liquidity in terms of equities trading, but also less accessible to foreign investors as well.
How does MSCI decide which countries are eligible to be in an emerging market index and which ones go into an index that represents more advanced economies.
MSCI uses three big criteria when they decide which countries goes to the which list. So three of that criteria includes the size and development of the economy. The second one is the liquidity of the equity trading, so how liquid a market is. And the third one, which is very unique for MSCI, is the market accessibility. It tries to measure how easy it is for foreign investors to access to buy and sell, and to get information about
certain stuffs that belong to the certain countries. So when all these three criteria means, that's when MSCI grants a certain market a developed market status.
Let's first talk about whether the economy is developed enough. So for Korea this is not an issue because as you can mention careers, basically a country in some standards as rich as Japan or France or Italy and Europe.
So basically it's not an issue. But for the second point, it's the size of the market and the market liquidity, which is also not an issue because you know, in Korea we have these big listed companies for example, just to name a few, like Samsung, LGCM or Hundiokia like these are big enough companies that's very actively traded by local Koreans but also by foreign investors. So the second point is not an issue as well. The market accessibility is really an issue here, so there are a few
things out sticking out there. First is the currency trading hours we just mentioned, so basically the career is only trading its currencies in its career market hours, which is an issue. So basically hinders the foreign investors' efforts to transfer their assets between Korean assets as well as foreign assets. So that has been an issue that MSCI asks Korea
to address. There are some other issues as well, for example, making it easier for foreign investors to register in Korea, making sure that every company is disclosing their financials in English, or making their dividend payment communications more transparent. There are some other small sticking points as well. So these are the things that really MSCI wants Career to address.
And I should say that MSCI declined to comment on Bloomberg story. You're young. Many of our listeners are in the US or in Europe. How will this affect people beyond Asia and beyond the machinations of financial markets?
American citizens they put in pension and these pension money gets allocated between developed market, emerging markets and frontier market and other stocks. So when South Korea leaves the Emerging Market index, these funds that allocate their money into emerging market funds will see more investment going into China. So that's how one way that American investors can be affected. South Korea's departure from the Emerging market indust could make
China be more dominant in the Emerging market index. Your pension money, you can't really ignore emerging market when you invest a huge part of money. Each pension or each fund has different mandates in terms of how much money they allocate to certain parts. But if you're in a big part of the pension funds or big part of the top ETF funds, then there are many funds that have to invest in the emerging market funds because you
can't really ignore how fast they're growing. This is the market where the big population growth is coming, big economic growth is coming. And sometimes depending on the years, emerging markets thought market may perform a lot better to development market, and if you are fund managers, you don't want to miss that.
Korea's entry into developed market indecks will have unintended consequence for investors that are investing in China assets. So when we think about it, currently, China is the biggest component for mscis emerging market indecks. It's one third of msci's Emerging Market INDECKS, but Korea, as we know, it's the fourth largest component. It's a significant exposure in the index.
But after Carea's departure, China will actually occupy close to half of that benchmark, which makes some investors nervous because it's half of the exposure to China and making the index probably less democratic compared with before with Career's departure.
And at the same time, investors have already been nervous about allocating this much exposure to China because of first US China relationships and second the slowing economic recovery currently here in China as well, and also in the long term, China also have demographic issues kind of similar story with Korea as well. So these are the issues that could make investors nervous when when it comes to investing in China in the long term.
After the break. Why is Korea so determined to make this leap? Young? South Korea very much wants to jump up into MCSI's World Index. Why is it so important to them to make that switch?
The stamp the MSCI grants as a developed market to South Korea could be a big boost to the national pride. And then there's this issue of the country's economic growth. Thus, Korea's economy is slowing, and it's because the country's population is shrinking and it's also aging.
The country has the.
World's lowest birthrate for more than decades, so the country needs more foreign participants from overseas in the stock market in order to help boost the slowing economy. Then there's this growing number of mom and pop stock investor whose number have more than double during the pandemic, and they're a very important part of the voting block for the current administration and for politicians, and having more foreign participant for the country's stock market could be a big boost to.
This mom and pop stock investor.
And finally, we could probably say that the MSc upgrade could be a big political win for the current government because the retail investor are such a big part of the voting blog and they played a very important role during the presidential elections last year. Current Sales, current president and other presential candidates have been promising that MSCA upgrade and a lot of these captive reform measures that will benefit the current stock market investors. So they were trying
to appeal to this growing and active retail investors. If the MSCI upgrades South Korea to develop market, then it will definitely be something that the current government would help as a big accomplishment.
Yu Keng, you mentioned mom and pop investors, What exactly do you mean?
So there are real mom and pop mother and father investors and the young stock investors in their twenties that are putting their money instead of in the savings account investing in stocks Korean stocks, US stocks in order to bring quick wealth, and that number has grown huge during the pandemic. There were I think now about a third
of the population invest in country's stock market. And this is the country with fifteen million popular and there's more than forteen million populations who are actually participating in buying stocks, and they are the ones who could get the benefit if the MSCA upgrades South Korean stock market and bring more foreign investments.
So now we come to the big question. Henry explained why Korea believes this bump up to the world indeck, we'd give it such a boost.
Starting back from square one, let's take a look at what happened if MSCI says Korea is now a developed market instead of an emerging market. So that basically means MSCI will remove carea from the MSCI Emerging Market indecks and at Korea into the MSCI Word Index or Developed Market indecks right now, which currently tracks twenty three developed markets,
but pending Career's entry, there will be twenty four. So this change, that will mean these emerging market investors there will pull money outside of Korea because the index tracking so MSCI Emerging Market indecks is no longer having career anymore. But at the same time, these investors, bigger global funds, bigger global investors that they track MSCI word indecks or the mscis Developed Market in decks, they will allocate some of their assets into the career stock market because MSCI
now has career in the MSCI word indecks. So you see there are ins and outs here, but the hope is there will be more inflows and outflows simply because the MSCI word indecks is tracked by more fund managers, tracked by bigger global funds, So basically because the poor is bigger, so there will be benefits for career. If career is elected in the word indecks.
Your young inflows and outflows. Could you give a sort of lay explanation of what that is.
So foreign inflows mean that there are more overseas investors buying Korean stocks then there are selling the stock, so they are buying more Korean stocks than selling the Korean stock. So that means a plus for the stock market in South Korea.
You kelling if this were to happen, what companies would really stand to benefit most from this?
South Korea accounts for about twelve percent of the current emerging market benchmark, whereas if it gets upgradd it will be just one or two percent of the developed market benchmark. So that means a lot of smaller or medium sized companies will see foreign investors selling their stocks, whereas the big company, the biggest one is STAMS Electronics, the second
big one is the Lgae Energy Solution. Those companies will likely to see more foreign investors buying their stocks, so it will be more beneficial to big companies, whereas we might see some negative impact on the smaller firms.
When we think about this, that means, as you co mentioned, Korea is the fourth biggest component in the MSCI emerging market right now, you can imagine it as a big fish in a small pond, but when it moved to the MCR word indecks, it's actually a bigger pond. But Carea is now a smaller fish because it only occupies
one or two percent of weight. So when fund managers allocate their money to MASH the benchmark weight, which is one or two percent, it doesn't necessarily mean that these smaller companies are not included in the MSCR word indecks. But for foreign fund managers to match that one or two percent weight, the only thing they need to do is to buy the biggest stocks to gain exposure to Korea, be it Samsun Electronics or be it LG cam Moor, Hyundai or Kia, So that's all they need to do.
So probably for these bigger investors, the less interest level compared with current emerging market fund managers when it comes to smaller financial stocks or let's say smaller industrial stocks. So that's probably a DRAWBF Koreas entering the developed market and exiting the Merging Market Index for.
MCI, when we come back, will Korea get its wish and if so, when.
So?
We've heard about one possible downside of this move that Korea wants to make and Yuke Young and Henry say there are other potential drawbacks too, So what.
We found out from our reporting is that they're actually hidden risk. In MSCI upgrade of South Korea to the developed market, foreign investors might sell more Korean companies than buying Korean companies, as was initially expected by the South Korean government, But in fact, what we found out is that actually more foreign investor will sell the company in Korea, which means that the shareholder pool will be more concentrated because on Korean retail investors or Korean funds that invest
in Korean companies with less foreign participation. This could especially be the case for the smaller and medium sized companies in South Korea if the MSCA upgrades, So stock market benefits more when there are ten more investors than just one or two, because you have more people you could sell at a higher price.
So what people.
Expect right now in the event of MSA upgrade is that if South Korea becomes a developed market, then there will be let's say, one hundred investors instead of like twenty investors trying to compete to buy one South Korean stock. But what we found out is that actually there may be fewer investors trying to buy Korean stocks, So instead of going from ten to hundred investors trying to buy one Korean stock, we may go down from one hundred
to fifty or even fewer. So instead of having American investors European investors trying to buy more Korean style, we may just end up having just Korean investors competing for the Korean stock. That's not a good news for the stock market investors who are trying to sell their stocks at a higher price. So that's why this is a drawback for the Korean stock market.
And what would the effect of this be on Korea's economy.
So South Korea's population is shrinking and the country's population is also aging. That means we may not have as many retail investors twenty years from now, thirty years from now because we're not having many babies now.
South Korea has the worst lowest birth.
Rates, so the country needs like better immigration policy and many other policy in order to help this slowing economy. But having more foreign investors participating joining the stock market to buy more Korean firms could help counter that shrinking
population effect. The Korean companies they roll their business by financing their money through the stock market, by raising their money through stock market, and they need more investors who are willing to pay their money out of their pocket and help these Korean companies to finance their investment and their future businesses. We may not be able to have that from Korean retail investors or Korea's big company investor, but we may be able to have that from the foreign investors.
If the country is upgraded to MSCI.
Markets don't often make that leap from the smaller pund to the larger pan When was the last time it happened.
It's Israel in twenty ten.
And how did they do? We're looking at how this could affect Korea and its economy investors. What did Israel see when they made the jump?
Okay, I think Israel is really good example showing why an MSCI upgrade is not a silver bullet for the local stock market. And there are lots of problems still remains in the Israel market so remains to be addressed. Even after the upgrade. The country struggle to attract any foreign investors investing in the local stock market. The local market also struggles to retain those most advanced companies, those
most innovative companies to list in local stock exchange. Instead, these companies would seek foreign exchanges, so for example, Nastac or New York Stock Exchange to list their companies. So why It's because the local market is still not advanced of the local market is still struggling to attract foreign investors. So when looking back, actually an upgrade for Israel to the MSCI Developed market is not a blessing for the local stock market because it's still struggle to retain its company.
It's still struggle to retain foreign capitals. So that's actually an example showing you why it's not necessarily the good case. Korea as an economy is much bigger than Israel's, so
the lessons could be different. But the key takeaway for Israel's upgrade is first it won't ground to immediate fortune after MSCI upgrade, and second, the local stock market needs to do more, needs to improve transparency, needs to prove for the companies, they themselves need to prove shareholder returns before they can attract more foreign investors buy into their stocks.
So, Henry, is this a case of the short term pain of making this switch is worth it in the long run.
When you think about the short term pain, so that would be these smaller companies at risk of losing out because of these global investors they tend to ignore these smaller firms but buying bigger firms. But it really depends, right, So you would argue that probably it's worth it because
it's definitely a step forward for the Korean market. So that's a recognition of the side of the economy, the advanced status of Korean's economy, but also as well, Korean must improve its market accessibility before MSCI to consider any upgrade to develop market status. So in the long run, you can make a case that this is probably a good thing for the Korean companies because they need to do more and because they're leaping forward from a smaller pund to a bigger pund so they're kind of forced
to do more. They are kind of having this incentive to achieve bigger things.
You're young. A lot of people, as you say, are waiting for this decision from MSCI. Where does it go from here? When does that decision come?
So MSCI announces this decision and market classification once a year every June, and at the end of June, it will announce which market belongs to the Developed List, Emerging Markets List, and Frontier Market List. A lot of fund managers, including Goldman Socks, expect that South Korea would be placed in the watch list of Developed market. You have to be in the watch list for at least one year before you get the final upgrade, and that system is
existing because MSCI doesn't want to surprise markets. It wants to give enough time for fund managers to prepare before the final change comes. And if MSCI announces that decision in June and say South Korea will be placed on the watch list for the developed market, that will be a huge deal for the country, and the Goldman Socks
is the one that's expecting that it will happen this year. However, there are also other fund managers who expect that happening a little later, possibly next year or maybe even the year after. But the consensus that we see emerging from a lot of these people is that is going to happen in coming years.
That we talked to think that Korea is definitely on the right path and Korea is on track to be added to at least the Developed Market watch list by MCI. Sometime down the road. But it can stay for one year, it can stay for longer. There's no guarantee because Korea was added to the watch list in two thousand and eight. However, the attempt was a failure because in twenty fourteen MSc I put it career outside of the watch list. So it really depends. So the story is unfinished.
Henry, you Young, Thanks so much for talking with me today.
Thank you so much for having us.
Thanks for listening to us here at The Big Take. It's the daily podcast from Bloomberg and iHeart Radio. For more shows from my Heart Radio, visit the iHeartRadio app, Apple Podcasts, or wherever you listen, and we'd love to hear from you. Email us questions or comments The Big Take at Bloomberg dot net. The supervising producer of The Big Take is Vicky Bergolina. Our senior producer is Catherine Rebecca Chasson is our producer. Our associate producer is Sam Gebauer.
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