Financial ETFs: Why Emerging Markets Are on Top

by: Tom Lydon

Out of the ashes of the financial crisis, emerging market banks have emerged stronger while developed market banks have languished. That makes emerging market financial exchange traded funds (ETFs) an interesting investment idea.

The Economist reports that developing market banks are now well-capitalized and well-funded, while enjoying rapid growth. In terms of profits, dividends and market value, developing banks now account for up to half of the global banking industry.

However, emerging market banks will have to find innovative ways to grow profits. According to an interview by Patrick Foulis, banking editor of the Economist, emerging market banks will need more capital than their retained profits can generate in order to meet the demands of rapid credit growth and its associated bad debt.

In the past, two models for banking business were attractive to foreign banks. The first was to have a huge network of banks in different countries to facilitate consumer needs. The second was to build huge retail operations that acted like local firms.

The two models are now almost impossible to replicate for firms looking to establish a presence in emerging markets, reports Foulis. This is because the first model requires an extended period of expansion, and the second requires an opportunity to seize market share from local banks, which is not likely to happen at the moment.

But the difficulty that foreign banks face when trying to enter emerging markets is mutual. Emerging market banks face the challenge of entering an increasingly regulated banking environment in developed nations.

Although developing market banks have risen with the emerging market tide, they will need to need to find innovative ways to access foreign markets in order to profitably grow their business into large-scale operations that make money.

One idea is to export competitive advantages. For example, in India, that would be low-cost technology. In Brazil, that would be investment banking.

If developing market banks are successful, related ETFs should also do well; many single-country emerging market ETFs have their heaviest weightings in the financial sector, including Market Vectors Indonesia (NYSEARCA:IDX), Market Vectors Africa (NYSEARCA:AFK), iShares MSCI Poland (NYSEARCA:EPOL) and iShares MSCI Thailand (NYSEARCA:THD). Look around – there are many more beyond these.

  • For broad exposure to emerging market financials, take a look at iShares MSCI Emerging Markets Financials (NASDAQ:EMFN). EMFN launched in January, so it’s still relatively new. It has holdings in China, Brazil, South Africa, India, South Korea, Thailand and several others.

Sumin Kim contributed to this article.

Disclosure: None