Private credit might be less attractive than it was last year as investors rush into the market, but there are sweet spots to be found.
South Korea and Taiwan, both classified as emerging markets by FTSE, were placed on a watch list for possible upgrade to developed market status two years ago. While both are already considered developed countries by the World Bank, they are still classified as emerging markets by FTSE and rival index provider MSCI Barra. FTSEÆs classification is based on a countryÆs economic status and on requirements related to how easily investors can have access to and divest from its market.
ôIÆm comfortable to say I would expect Korea to meet the standards in time for the review next year,ö says Mark Makepeace, London-based chief executive at FTSE. ôFor Taiwan, itÆs more difficult for me to say that because there are still five items for them to address. Some of those require regulator or central bank action and itÆs not always easy to coordinate among these groups. There is certainly the intent or willingness.ö
South Korea failed to meet three requirements during FTSEÆs latest country classification review, the results of which were announced last week. South Korea didnÆt have in place a ôfree and well-developedö foreign exchange market, free delivery settlement, and off-exchange transactions.
Makepeace says South Korea already has a plan to improve delivery settlement and off-exchange transactions, which will be introduced before the end of this year. The final obstacle that remains is the foreign exchange restriction, and the central bank has announced this will be addressed before year-end and changes will likely be implemented in the first half of 2008, he says.
ôThere are market practices [in South Korea] that have to change,ö Makepeace says. ôInternational investors cannot get their foreign exchange transactions done at the time they make the investment decisions. They have to wait until settlement or enter into an agreement with a bank, and that causes delays and exposes what theyÆre doing.ö
Being elevated to developed market status is expected to translate to a significant increase in fund inflows for South Korea, and this will likely occur in stages. Some of the new funds will come sooner from investors who position themselves ahead of any index classification change, while the rest will come later from passive investors who strictly track benchmarks. FTSE estimates that some $3 trillion in funds are benchmarked against its indices worldwide, mostly in developed markets.
Having a developed market status leads to a more stable level of international investments. Investors that allocate based on indices tend to earmark around 30% of their portfolios to developed markets. Large pension funds worldwide tend to prefer investing in developed markets.
Emerging markets, meanwhile, tend to be the territory of active fund managers, who tend to increase or decrease their investments a market or a company depending on their current view and outlook. Thus, fund flows tend to be more volatile compared with developed markets.
Makepeace expects significant changes in the emerging markets landscape in around five yearsÆ time.
In Asia, Makepeace says the China-A shares market is a good candidate for possible inclusion as a secondary emerging market in FTSEÆs global equity index series, although it may still be a long way off from actually being part of that list. China-B shares and H-shares are already in the global equity index series, which is used by regional and global fund managers. China-A shares are only in the secondary emerging market country classification, a consequence of the relative lack of freedom of foreign investors to access that market.
ôThe China-A shares market is clearly some way off [from meeting FTSEÆs requirements], but the Chinese authorities have the ability to address this issue. They need to expand and simplify the QFII (qualified foreign institutional investors) program and if they do that, thatÆs a key criteria,ö Makepeace says.
Other possible candidates for emerging markets classification are markets in the Middle East and Africa, Makepeace says, adding FTSE may publish an analysis of the level of compliance of Middle East markets to the FTSE requirements next year.
FTSEÆs business is growing in Asia, but still has to catch up with its expansion in Europe, which is a major market for the index provider.
In Asia, FTSE has been growing its business by entering into partnerships with local stock exchanges to modernize or take over the calculation of their indices, and to help bring more products to the market. The latest partnership involves creating a new series of equity indices for the Stock Exchange of Thailand, which will be available by the first quarter of 2008. Other partnerships include those with the stocks exchanges in Taiwan, Malaysia, Thailand, Singapore, and China.
Regulators keep their eyes open on tightening insurance industry by introducing more detailed risk management requirements, which could bring pressure on smaller players.
China and India are more obvious choices for AustralianSuper to consider in Asia Pacific, but the super fund currently lacks the expertise and prefers to stick to the US and Europe.
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