Three Classifications For Foreign Markets

The July/August 2011 issue of the Journal of Indexes includes an article making a case for the establishment of a third classification of foreign markets: Frontier.  Dow Jones is reorganizing its foreign equity indexes to reflect the three categories.  Markets, and the equities traded on them, are to be groups according to what Dow Jones terms market-centric attributes and investor-centric experiences.  The factors considered either introduce additional costs of trading (settlement cycle, foreign capital flow restrictions) or incremental risk (differential treatment of domestic and foreign investors, public availability of trading data).  The figure below indicates how markets stack up in the new classification system versus versus total market capitalization.

 

Table courtesy of Journal of Indexes

What I did not expect was the extent of the overlap of developed and emerging markets.  A couple of names also stand out for being better developed than expected: Hong Kong and Singapore among the developed and Russia among the emerging.

Normally, I would consider this a marketing gimmick on Dow Jones part, trying to create differentiation where there is no difference.  However, given the factors considered, I think that a credible case has been made that investing in the Frontier markets presents different risk exposures than investing in Either
Developed or Emerging markets.  Indeed the final figure ion the article indicates that the Frontier markets had a lower correlation with the other two classifications than Developed and Emerging had with each other.

Look for products to be developed using the new classification, most notably ETFs.  Once we get a critical mass of capital applied to the new classifications, we can perform the experiment of comparative value of three- versus two-class foreign equity investing.