MSCI Reclassification Puts Spotlight on These ETFs

By Benzinga | June 10, 2013 AAA

Traders have had bigger fish to fry over the past few days, but a potentially noteworthy news event is slated for the after-market docket on Tuesday.

That is when index provider MSCI (NYSE: MSCI) unveils its annual market reclassification, an event that could impact a raft of ETFs tracking developing and frontier markets.

On the other hand, this even has the potential to be anti-climatic as it was last year when MSCI again declined to move South Korea and Taiwan to developed market from emerging market status. To its credit, MSCI does not take market reclassifications lightly.

The last time it changed a market's classification was in 2011 when it demoted Trinidad & Tobago to standalone from frontier. The last time an ETF was affected by an MSCI reclassification was May 2010 when Israel promoted to developed from emerging market. It has taken a while, but the iShares MSCI Israel Capped Investable Market Index Fund (NYSE: EIS) is finally close to getting back to where it traded after the upgraded. Several months, later EIS surged only to enter a multi-year tailspin after becoming a developed market ETF.

Here are some of the ETFs that could be in focus if MSCI delivers some surprises on Tuesday.

iShares MSCI Emerging Markets Index Fund (NYSE: EEM)
An obvious choice to be sure, but the second-largest emerging markets ETF by assets allocated over 25 percent of its combined weight to South Korea and Taiwan at the end of the first quarter. Both have been inline for a promotion to developed market status for several years and many investors believe that at the very least South Korea should get the nod.

To this point, MSCI has declined, citing the fact that the South Korean won is not easily convertible for offshore traders. Arguably, it is a pedantic issue given that other emerging markets featured in the MSCI Emerging Markets Index only have partially convertible currencies. The Indian rupee is one example.

If MSCI does decide to promote South Korea, the move will probably be met with some near-term hysteria, but Vanguard has already shown the world that it is easy to move a major emerging markets ETF away from South Korean stocks without causing a panic. That is what the Vanguard FTSE Emerging Markets ETF (NYSE: VWO). Interestingly, the performance difference between EEM and VWO is not significant this year.

Prediction: MSCI leaves both South Korea and Taiwan as emerging markets.

iShares MSCI Frontier 100 ETF (NYSE: FM)
Yes, it has already been said that FM will be in play this week, but with Qatar and the United Arab Emirates combining for almost 28 percent of FM's weight at the end of the first quarter, the advice bears repeating.

FM and other ETFs with even larger allocations to Qatar and UAE, such as WisdomTree Middle East Dividend ETF (NASDAQ: GULF), have been stellar performers this year, trouncing traditional emerging markets funds in the process.

The impact of the MSCI news on FM, GULF and others will be interesting to say the least. As is the case with South Korea's "not yet" promotion to developed market status, some investors believe UAE should have gotten the nod to emerging markets territory long ago. MSCI has rejected Qatar and UAE five years in a row. How long that dance can be kept up is anyone's guess, but the index provider is running out of excuses, particularly with UAE.

Qatar recently took action to lift foreign ownership limits on its major exchanges, but that news broke last week and it may not be enough to appease MSCI this year, though it is a good move for 2014's reclassification.

If UAE is promoted and Qatar is not, how FM rebalances will be noteworthy as well. Educated guess: The ETF's weights to Nigeria, Pakistan, Kazakhstan and Vietnam will increase. Prediction: UAE gets the nod, but Qatar does not.

For more on ETFs, click here.

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