S. Korea Has Outsized Impact on Emerging Indexes

In 2012, Vanguard announced that they were changing the benchmarks that they track for a large number of their funds. Their domestic stock funds, which had followed indexes created by MSCI, would soon track indexes created by CRSP.

Since we don’t use any Vanguard mutual funds or exchange traded funds (ETFs) that track US markets for private clients, that change didn’t impact us.

However, we do use Vanguard ETFs for our non-US holdings in both developed and emerging markets. In the past, Vanguard’s non-US funds had tracked MSCI indexes and now they benchmark indexes created by FTSE.

When Vanguard made the announcement, they issued some back-tests that showed how the old and new indexes compared. While there were some differences, the results were very similar.

In 2013, the first year of live performance with the new FTSE indexes, the results closely matched the MSCI indexes.

This year, however, the results between the two emerging markets indexes are quite different. The FTSE Emerging Markets Index is up 4.83 percent and the MSCI Emerging Markets Index is only up 1.09 percent.

Since our reports compare the Vanguard fund that tracks the FTSE index and the benchmark is still the MSCI index, we look outstanding. I want to say, though, that it’s purely luck in this case and, unfortunately, there will be times when our results look different (worse) than the index.

It turns out that there is one major difference between the two indexes – the FTSE series includes S. Korea in the developed markets and the MSCI index has S. Korea as an emerging market.

This year, S. Korea is down substantially and since it is the largest country weighting in the MSCI indexes, it is weighing them down.

In future years, there will undoubtedly be a time when S. Korea is doing fabulously and the MSCI index outperforms the FTSE index and we look bad compared to the MSCI benchmark in our reports.

At some point, we may elect to switch the benchmarks in our reports, although non-US funds often don’t track non-US indexes very well due to time zone differences (that’s a whole story unto itself).

The real key is to understand what the benchmark really means and recognize that results vary from time-to-time, sometimes for good reasons.

Benchmarks are useful, but like everything else, they can easily be misunderstood and misused.