This fall, investment giant Vanguard Group made a relatively arcane business decision, switching the benchmark tracked by one of its most popular exchange-traded funds, the Vanguard MSCI Emerging Markets ETF, from MSCI's version to that of a rival FTSE. The company said it was simply looking to lower its licensing fees.
But because those two index providers classify emerging markets differently, South Korea, one of the biggest emerging-markets success stories of the past decade with an average annual return of 13%, could be bumped from the fund's portfolio.
The move has irked some investors that have long looked to the old indexes as a way to precisely gauge market returns. "Everyone's benchmarked against MSCI," says Morningstar analyst Patricia Oey. More important, say critics, returns in the emerging-markets ETF could trail its peers if South Korean stocks continue to rise.
Judgment in some quarters was swift: Investors yanked $900 million from the fund in November, even as other emerging-markets ETFs had inflows.
Vanguard Principal Joel Dickson acknowledges the company's move prompted "some pushback" from customers, but says the new licensing deal lowers costs. He adds that investors who still want exposure to South Korea can buy Vanguard's developed-markets ETF.
The controversy has its roots in the esoteric details of indexing. FTSE and MSCI use nearly identical methods to design indexes, weighting stocks based on their market value. But South Korea is a sticking point. The country's economy boosted by household name brands like consumer-electronics giant Samsung and car maker Hyundai has left experts divided over whether it still qualifies as an emerging market like China and Brazil. Last year, for instance, the U.S. government pegged South Korea's per-capita GDP at about $31,000, roughly in line with Spain's and about four times China's.
South Korea's success means it looms large next to developing countries. Korean stocks represent about 15% of Vanguard's ETF and other popular funds like iShares MSCI Emerging Markets Index ETF (NAR:EEM) that track the same benchmark, more than any other country other than China. And South Korea has been a big help to performance. In the past decade the country's stocks have returned 12% a year on average, compared with about 8% a year for emerging markets broadly, according to fund researcher Morningstar Inc.
To Atlanta-based financial adviser Matthew Reiner, the change presents a conundrum. Because he owns a developed-market fund pegged to an MSCI index, his clients may be left without any exposure to South Korean stocks. As a result, he says he is considering dumping Vanguard MSCI Emerging Markets ETF. He plans to make up his mind by the end of the year. "It comes down to, 'Do we like Korea or not?'" he says.