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In these times of financial uncertainty, nee outright fraud and mismanagement, the shrewd investor who decides a particular emerging market is one way to escape this reality is likely to be dismayed when he looks at the portfolios of many single country ETFs only to find them dominated in their holdings by none other than financials.


(Click to enlarge)

As investors are we to be spared nothing in our desire to avoid the clutches of bankers? Or are we trapped in their webs? Of course we aren't. Financials are an extremely important part of frontier and emerging markets, especially those whose growth was spurred on by central bank credit creation. Since I operate out of Vietnam, and that is my focus, I put together the following chart to illustrate the weighting by ETF for much of the Pacific Rim.

Sector

# of Stocks

% Index Weight

Financials

47

47.66%

Consumer Staples

42

25.97%

Industrials

85

8.00%

Materials

52

7.33%

IT

8

2.90%

Energy

10

2.15%

Consumer Disc.

26

2.07%

Utilities

14

1.99%

Health Care

10

1.62%

N.A.

11

0.31%

Breaking this down, we'll take the Market Vector Vietnam ETF (VNM) as an example for some of the issues at work. While VNM is designed to track Market Vector's Vietnam Tracking Index and not the VN Index, which you can think of like the S&P 500 for Vietnam, both are capitalization weighted and financials are among the highest market cap companies.

Vietnam is one of those countries who grew via central bank stimulation and the banks are their transmission mechanism for monetary policy. As heavily weighted as VNM is the VN Index is even more so, at nearly 48%.

Note the differences in allocations between VNM and the VN Index, while consumer staples, like dairy giant Vinamilk, account for 26% of the VN Index, VNM allocates a similar amount to energy. Some of that is due to a lack of foreign room in many quality Vietnamese companies forcing VNM to take positions in lesser quality companies such as Bao Viet Holdings and Hoang Anh Gia Lai.

But, like it or not, the financials are generally still a good path towards investing in an emerging market as many companies will have a much harder time obtaining equity financing versus debt financing. And since debt financing is pervasive, the banks will be the early beneficiaries of a company's success. The following chart gives an idea of how powerful this can be for capital intensive projects which is where the bulk of early investment must flow in order to support higher order stages of production, such as services.


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The first three companies in the chart are all hydro power companies. Note how the Interest % of Income is inversely correlated to market cap. SBA and SJD are both younger companies who are just now hitting their production strides but whose bottom line is being eaten up by their loan payments. As they grow and pay down their debt their net margins and income will explode.

This approach is, obviously, not without risks. The banking sector in Vietnam is disproportionately large and a metaphor for what is happening all around the country in a number of sectors that were over-stimulated by the accommodative monetary policy of last decade and cannot survive in the current high interest rate environment. The headlines are now dominated by companies struggling in real estate, construction, fishing, etc. The number of bankruptcies has soared 57% in 2012. M&A activity, especially in the banking sector is beginning to accelerate.

Retail banking giant Sacombank was recently at the center of a three-way power play for control of the company by Eximbank and Asia Commercial Bank who both wanted to exert more control over Sacombank by increasing their positions and control the board. This three-headed entity is now the 5th largest financial firm in Vietnam. The smaller banks are having trouble maintaining adequate capital ratios and are, in particular, targets for takeover. Habubank was recently acquired by Saigon Commercial Bank. The State Bank of Vietnam has ordered a number of banks to submit restructuring plans to them by September or have it forced upon them.

But, this is the eye of the financial storm as the interbank money market has stabilized considerably in the past 2 months; resuming a normal rising rate curve that gives the State Bank the latitude to allow credit to stabilize and advance again. Vietnam is such a compelling investment story from a macro perspective that it becomes easy to overlook these short-term problems, especially now post-tightening cycle, post-crash.

Among the factors driving my investment thesis on Vietnam are:

  • Geography which makes it the gateway between the Asian powerhouses Japan, South Korea and China (the "+3" in the "ASEAN+3" block).
  • Capital flight from the West to the East due to fiscal and monetary mismanagement by the U.S. and the E.U.
  • Balkanization of trade into regional blocks due to structurally high energy prices brought on by populous frontier and emerging market growth.
  • Golden ratio of population demographics which Vietnam (and Cambodia) are entering where there will be 2 workers per dependent for the next 30 years.
  • Reverence for education shared with its Asian peers.
Source: Why Financials Dominate Emerging Market ETFs: The Case Of Vietnam