Income-seeking investors cannot ignore EMs, managers say

Should Poland strengthen its GDP in line with Eurozone and continental European economies, the possibility of its upgrade becomes more certain.

However, as Teverson explained: "The upgrading of a country from emerging to developed market status is a relatively infrequent event. The last time MSCI upgraded an emerging market was in 2010, when Israel was reclassified to a developed market."

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Moreover, even South Korea - which is home to global brands such as Samsung Electronics and Hyundai Motor - will need to have further reform and liberalisation of market access before the country could be reclassified by MSCI. 

That said, Teverson said this could certainly happen before 2030.

Lister added: "It is reasonable to expect the likes of China, Korea and Taiwan, which currently make up two thirds of the EM Index, to be candidates for reclassification as developed markets, based on their size, economic growth and rising GDP per capita.

"Changes to such large components of popular benchmarks obviously prompt substantial flows of capital, both active and passive, which would undoubtedly have to be completed in a phased fashion. 

"Being on the right side of such changes can be rewarding in the short term, but shouldn’t be the driver of a long-term strategy. "

Potential drags

Earlier in March, China held its annual National People’s Congress, during which the government said it was targeting 'above 6 per cent' GDP growth this year.

This is down on the 8.1 per cent predicted by the IMF in January this year, but still outstrips that of the UK, the US and the European Union. 

Add to this the strength of China's stockmarket, which emerged well in 2020 after the global lockdown caused by Covid-19, and it does currently present itself as a front-runner for MSCI reclassification over the next decade. 

However, there are potential drags on its performance for long-term investors, which both Teverson and Lister have outlined.

One long-term consideration for UK investors will be China’s weighting within emerging markets. China’s concentration in the benchmark is approximately 40 per cent of the MSCI Emerging Markets Index.

Teverson said this could become problematic "in the event Chinese equities enter a more challenging period, which is possible, given the country’s high levels of aggregate debt and elevated valuations in certain parts of the market".

In this case, investors may come to question the wisdom of having such a high single-market concentration in an asset class that extends across 27 countries.

This is reflected in the current sector allocation of the Aberdeen Emerging Markets Investment Trust, where Lister's weighting to China is at 31.9 per cent of the portfolio, compared with 39.5 per cent in the MSCI Emerging Markets benchmark index.