Right now, south of the equator, Peru is engaged in a big showdown -- it's fighting tooth and nail to keep its place in an influential stock index. This comes on the heels of a recent decision that keeps a whole swath of the Chinese market out of this very same index.
The countries may be wildly different and located at opposite ends of the world, but they are both chasing your investment dollars.
The reason comes down to major index provider
You have to look no further than the rise of ETFs to start to understand why. As these low-cost funds that track various indexes have exploded in popularity in recent years, investment in them has grown. MSCI's emerging markets index is particularly popular, with a whopping $1.7 trillion tracking it, as passive investors seek diversification by investing abroad.
Getting bumped from this heavyweight index can be really bad news for a country like Peru, which has a lot to lose. A demotion to frontier market could trigger outflows of up to $5 billion, according to Peru's finance minister Alonso Segura, and is being called "a significantly negative threat" to the country's markets and economy by Peru's stock exchange.
"A lot of money can shift," says Michael Iachini, managing director of mutual fund and ETF research at
If Peru were to be kicked out of the emerging markets index, it would instantly rise to the top of the frontier index. The argument can be made that it's better to be a big fish in a small pond. One only has to look to Nigeria for an example of a country that was able to raise its profile by entering the frontier index.
Still, it's all relative. "The pool of investors [in frontier markets] is way less than in emerging markets," lamented Christian Laub, Chairman of the Board of the Lima Stock Exchange, when asked about this potential silver lining at a small press conference at the New York Palace hotel last week.
"If you want the following, it's important to stay," agrees Gary Kleiman, co-founder of Kleiman International Partners, an emerging markets advisory firm.
Still, it means little for the average investor. Peru accounts for a tiny 0.4% of the emerging markets index. If a fund in your portfolio tracks the index, you own just three Peruvian stocks. Most of your money is spread between the the index's 827 other stocks, starting with South Korea's giant Samsung.
"A Peru reclassification is going to be very minor and is not going to make a big difference," says Kleiman.
Source: MSCI, Forbes
"Is anyone going to notice?" asks Iachini. "For anyone with an ETF, the answer is no. It's really just too small."
The same is probably true for other recent changes, like when Qatar and the United Arab Emirates were added to the emerging markets index last year. They each account for about 1% of the index.
However, size does matter. When you start talking about moving heavyweights from index to index, investors would do well to pay attention. For instance, for years there's been chatter about South Korea, which has been under consideration for a promotion from an emerging market to a developed market. It currently represents an entire 14% of the emerging markets index, so if it's suddenly reclassified, the index would change substantially.
Another biggie is China. It already lays claim to a quarter of the emerging markets index -- and that's just with a portion of its stocks included. If China's A-shares -- domestic stocks listed on the Shanghai or Shenzhen exchange -- were included, the index would be much more heavily tilted toward Chinese stocks. This summer MSCI decided to hold off on accepting these shares into the index, but it is expected to happen some time down the road.
Any big changes (index weightings of 10% or more that get added or subtracted, says Iachini) could alter the risk present in your portfolio or change your level of diversification or exposure. Are you suddenly doubled up on a huge country, or lacking investment in it altogether? Is there more volatility?
The job of index providers like MSCI is to fully represent some investable universe (for instance, the S&P 500 is a good gauge of U.S. large cap stocks). Still it's up to investors to know what's in an index and decide if they want to track it.
"Peru ends up being a pretty easy call, you're not going to lose any sleep over this," says Iachini. "But if a country that's going to be 18% of my portfolio gets added, I'd think that through."
