Emerging markets ETFs represent the crossroads of two of the hottest investment trends of recent years. As the U.S., Japan, and developed European economies struggled to pull out of recessions and avoid a double dip, the world’s emerging economies raced ahead, led by the BRIC bloc of nations. According to the International Monetary Fund, the economies of China and India are expected to increase by 10.0% and 7.7% in 2010, compared to 2.7% for the U.S. and 2.1% for developed economies in aggregate.
ETFs have also seen their popularity surge. More than 100 new funds were launched in 2009, bringing the total above 900. ETFs saw almost $120 billion in cash flows as investors continue to embrace the exchange-traded structure in favor of traditional mutual funds. So it is not surprising that ETF options for gaining exposure to emerging markets have begun to multiply, with new innovations offering investors more flexibility and more options. Perhaps the most important innovation has been the introduction of sector-specific emerging market funds, allowing investors to target certain industries in developing economies. Previously, gaining exposure through emerging markets ETFs had largely been a binary option: you either had it, or you didn’t. There was no way to access the energy sector without also investing in tech companies, banks, and consumer products.
EFN vs. EMFN
But new innovations have brought options for increased portfolio granularity. New York-based Emerging Global Advisors has been the pioneer in this space. In addition to a broad-based emerging markets ETF (EEG) and sector-specific metals and mining (EMT) and energy (EEO) ETFs, EGA offers the Dow Jones Emerging Markets Financials Titans Index Fund (EFN), the first ETF to target the financial sector of emerging economies. Earlier this month, iShares launched the MSCI Emerging Markets Financials Sector Index Fund (EMFN).
The similar names and tickers for these ETFs may lead some investors to believe that EFN and EMFN are interchangeable. But a look under the hood of these ETFs reveals that they’re not as alike as they seem.
Case For Emerging Markets Financials
The case for investment in the financials sector of emerging markets is a relatively simple one. As the trend towards urbanization continues in the world’s developing economies, more and more people are leaving behind agricultural unemployment for a job in the rapidly-expanding cities. As the urban population grows, so to does the middle class and discretionary income. “For example, millions of Chinese are moving into the $5,000 to $6,000 salary base, which is when consumers typically start moving from pure staple type consumption to actually starting to consume discretionary items,” said Bruno del Ama, CEO of Global X in an interview with ETF Database.
As emerging markets progress towards developed status, quality of living and per capita income are generally expected to increase, as is the need for savings and checking accounts. This change in demographics also translates into more purchases of big ticket items like cars and houses–opportunities for financial institutions to expand their business operations without turning to excessively-risky investments.
Holdings Analysis / Country Allocation
|EFN as of 12/31/09, EMFN as of 9/30/09|
The overlap between these two funds is perhaps not as significant as might be expected due to fundamental differences in the methodologies of the underlying indexes.
EGA’s funds are based on Dow Jones indexes, which offer “pure play” emerging markets exposure by tilting holdings towards the BRIC bloc of countries and avoiding investments in the quasi-developed markets of South Korea and Taiwan. The iShares take on emerging markets financials gives an aggregate weighting of about 18% to South Korea and Taiwan.
The International Monetary Fund has classified South Korea and Taiwan as developed economies for more than a decade, and the per capital GDP, literacy rates, and HDI scores of these nations are much more similar to the U.S. than to the BRICs. The index on which EFN is based has an aggregate weighting to the BRIC economies of about 70%, significantly more than the 53% weighting given by EMFN’s benchmark (read more on the quasi-developed nature of South Korea and Taiwan in this feature).
Other Key Metrics
In terms of depth of holdings and expenses, these two ETFs also have some significant differences. EMFN charges 0.72% annually, while EFN has an expense ratio of 0.85%. EFN has about 26 holdings, the largest of which are the Industrial & Commercial Bank of China (8.5%) and China Life Insurance Co. Ltd. (8.2%). iShares is yet to publish the holdings of EMFN on its Web site, but the ETF’s fact sheet indicates approximately 90 individual holdings.
Both funds are relatively new products, so neither has huge trading volumes, but for the time being EFN offers far superior liquidity. Average daily volumes for this fund are about 5,000 shares, but have been as high as 45,000 shares in recent sessions over the last month. EMFN is currently throwing up some major red flags in this area: the fund has only 100,000 shares outstanding, and daily volumes appear to be non-existent.
EFN and EMFN both offer exposure to one of the fastest growing sectors of emerging markets. But despite some overlap in holdings, these ETFs are far from substitute products. Investors looking to establish pure play emerging markets financials exposure will likely find EFN to be a better option, while those looking for more depth of holdings might like EMFN.
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Disclosure: No positions at time of writing.