Russell Indexes has downgraded Greece to emerging market status as part of its annual index reconstitution process. The decision by Russell results from a three-year market risk review process in which Greece did not meet macro- and operational risk criteria for developed market status, but did meet classification criteria for inclusion in emerging markets.
Russell’s country classifications are announced each year in March and any changes become effective at the conclusion of its annual index reconstitution process in late June.
Mat Lystra, senior research analyst at Russell Indexes, said: “Our analysis of Greece and conclusion to reclassify its market status has been guided by the rules-based, objective and transparent methodology for Russell Global Indexes.”
Russell’s reconstitution process includes an intensive review of numerous market factors to recalibrate the indices each year to reflect current market conditions. As part of the reconstitution, the company analyses risk factors and country classifications as part of a dynamic, long-term market risk review designed to identify material changes to the risk and investability characteristics of countries included in its indices.
While downward reclassifications are rare, they do occur if a country no longer meets the criteria for its current classification. For Russell indices, it takes three years of sustained changes in economic criteria for a country to be reclassified, and reclassification can happen in different ways. A frontier or emerging market country can advance to emerging or developed status, while a developed or emerging market country can shift to emerging or frontier.
Essentially, developed markets, in general, are deemed to be the least risky and most efficient in which to trade, with emerging and frontier markets progressively more risky and less efficient.
While ejections from bond indices are relatively frequent, typically following changes to credit ratings, downward movements in equity indices are less common. That said, Greece may not be alone as Argentina may soon follow a similar fate. FTSE has put the South American country, which was downgraded from Secondary Emerging to Frontier in 2010, on watch for possible demotion from Frontier status due to continuing stringent capital controls imposed on international investors and the perceived lack of an independent regulatory authority to protect the rights of shareholders.
Following the closure of the Global X Russell Emerging Markets Growth ETF and Global X Russell Emerging Markets Value ETF in February 2012, no ETFs are likely to be impacted by Russell’s reclassification of Greece. However, MSCI and FTSE also have Greece on watch, and so a downgrade by either of these index providers would have ramifications for numerous ETFs, especially those tracking emerging market indices, such as the FTSE Emerging Index and MSCI Emerging Markets Index, which would likely have to add Greek stocks to their portfolios.