For years, hedge fund managers were the undisputed masters of the universe. They influenced the fortunes not just of companies and markets but countries too.
No more. They have been usurped at the top of the financial food chain by a new breed of market savant. Nowhere is the power shift more apparent than in South Korea.
When Korea was reeling from the Asian financial crisis in 1998, its president-elect, Kim Dae Jung, called in George Soros for advice. The billionaire investor, who’d been vilified in South Asia for profiting from the economic chaos, arrived in Seoul to red-carpet treatment. After three days of meetings, he addressed the local media. “This is a very severe problem,” he said. “But I think it can be overcome within a relatively reasonable period of time.” He suggested that if policy makers pushed through his prescribed reforms, his Quantum Fund would invest substantial sums into the economy, and others would likely follow. In the 10 days after his visit, the Korean market benchmark rallied 28%.
Today’s playmakers don’t have the same name recognition as George Soros, but they are no less powerful.
There are three of them: S&P Dow Jones Indices, MSCI and FTSE Russell. Their nondescript names mask their enormous influence. Between them, they design, calculate and manage hundreds of thousands of financial indices that steer capital around the world. In total, over $50 trillion of investor funds are benchmarked against metrics that these three entities control. (Bloomberg LP, the parent company of Bloomberg News, competes with these firms in providing indexes and financial data.)
Like the hedge funds before them, it’s not just companies that fall under their gaze but countries too. By setting the criteria for index membership, they act as gatekeepers, determining which countries are eligible for investment by many of those funds.
One country sitting at their gates is South Korea, where their judgments have become an issue in the upcoming presidential election. Despite recovering from its crisis and growing to become a top 10 global economy in the past two decades, South Korea is still classed by MSCI as an emerging market rather than a developed one. So, while its listed companies have access to the $960 billion of funds benchmarked against MSCI emerging market and related indices, they are ineligible for investment from the roughly $3.6 trillion pool of funds that tracks developed market indices.
Lawmakers in Seoul are not happy. Over the years, they’ve offered MSCI the same red-carpet treatment they once offered Soros — to no avail. Now, as the country heads towards the March 9 vote, one leading candidate has pledged to attempt to secure an upgrade to developed market status. In parallel, the finance minister has proposed changes to Korea’s foreign-exchange regime to address one of MSCI’s principal concerns.
The rewards are enticing. Goldman Sachs Group Inc. estimates that net capital inflows resulting from a change in classification could amount to $44 billion. Perhaps more importantly, reclassification bestows the imprimatur of a globally recognized standard-setter. Assuming this leads to a narrowing of South Korea’s valuation discount against other developed markets, Goldman Sachs analysts reckon it could add 35% to the value of the market.
Indices were never meant to command such influence. They started life as simple confidence barometers, sponsored by newspapers as a daily service to their readers. But as Mark Makepeace, former head of FTSE Russell, observes, “Humans gravitate to order, making sense of information by grouping it into families to rank and review.” Such gravitation led the investment industry first to adopt indices as performance benchmarks and then to track them as the end unto themselves.