The world's two largest emerging market exchange-traded funds (ETFs) have long been viewed by investors as nearly interchangeable investment vehicles for over a decade.

Now, a long-standing debate over whether South Korea should be classified as a developed or an emerging economy has led to a record performance gap between these two ETFs from BlackRock and Vanguard.

Over the 12 months ending June 30, the iShares Core MSCI Emerging Markets ETF (IEMG) from BlackRock, with over $150 billion in assets, delivered a return of nearly 40%. In contrast, Vanguard's equivalent product (VWO) returned only about half that amount over the same period. This divergence is particularly striking for two funds whose performance has historically moved in near lockstep.

The reason ultimately points to South Korea. Over the past year, the benchmark Kospi index has surged more than 170%, driven by soaring share prices of Samsung Electronics Co Ltd and SK Hynix Inc amid the artificial intelligence (AI) boom. BlackRock's product, which tracks the MSCI Emerging Markets Index that includes South Korea, has directly benefited from this rally.

In comparison, Vanguard's corresponding ETF (VWO), with approximately $120 billion in assets, missed out on this wave of gains. This is because it tracks the FTSE Russell Emerging Markets Index, which excludes South Korea as the index provider classifies it as a developed market.

This phenomenon also highlights the risks inherent in a "set-it-and-forget-it" investment approach during an era where returns are dominated by a handful of markets or individual stocks.

Over the past year, share prices of Samsung Electronics Co Ltd and SK Hynix Inc have soared, fueled by the AI wave, propelling the benchmark Kospi index significantly higher.

The South Korean case may also foreshadow broader index-related disputes in the future. As major index providers adopt different stances on when, or even if, to include mega IPOs like SpaceX in their flagship indices, similar controversies could become more common. This means that choosing a passive fund is increasingly becoming an active decision—investors are effectively selecting a specific benchmark index.

"The impact of the benchmark index will become increasingly important in the future," said Michael Firestone, Chief Investment Officer at Fire Capital Management. "Investors must clearly understand what they are investing in."