Traditionally, investments in emerging markets such as India and China have been viewed as riskier than investments in developed economies. Part of this perceived additional risk is related to less developed financial markets and regulatory oversight; the lack of standardized reporting and robust audit requirements and restrictions on repatriation of assets creates the potential for significant inefficiencies. Another big part of this risk is political in nature; unstable emerging market governments have a long history of nationalizing private companies. Ranging from from oil companies in Venezuela to copper mines in Chile and banks in India, these events have stuck in the minds of investors, and have long been held up as justification for an additional risk premium demanded from emerging markets investments.
But the last two years have brought a reshuffling of the global totem pole that has caused investors to rethink the assumption that economies classified as “emerging” are inherently more risky than those classified as “developed.” Nearly every developed economy has completed a bailout in some form, giving governments a material ownership interest in everything from banks to automakers. Moreover, the U.S. president threatened to levy a windfall profits tax on energy companies and Congress recently passed a sweeping health care overhaul that could materially impact the operations and profitability (both positively and negatively) of industries from insurance providers to device manufacturers. With a bill now being kicked around Capitol Hill that could dramatically change the way everyone from Harley Davidson to Goldman Sachs trades derivatives, it appears that the financial sector is next up.
The proposed overhaul of regulation of the financial industry is far from final, and the ultimate impact on profitability of Wall Street is a big unknown. The uncertainty now hanging over the sector has created anxiety among investors and pushed trading volumes and volatility in financial ETFs through the roof in recent sessions (see Five ETFs With Surprising Turnover). While some investors thrive on this volatility, others have begun looking for ways to establish exposure to financial companies that doesn’t involve significant political risk.
Emerging Markets Financial ETFs In Focus
There are a handful of global financial ETFs available, but most of these companies maintain significant U.S. allocations. The iShares S&P Global Financials Index Fund (IXG), for example, allocates about a third of its holdings to the U.S. and another 10% to the U.K. (see How Global Is Your Global ETF?). It may sound unconventional, but investors looking for financial exposure without all the political risk may be best served by turning to emerging markets financials ETFs.
There are two ETFs that fit this description:
The Dow Jones Emerging Markets Financials Titans Index Fund (EFN) tracks an index comprised of 30 of the largest emerging markets companies in the financials industry, including banks, insurance, and real estate firms. EFN gives the largest weightings to China and Brazil, and also maintains exposure to several additional emerging economies. In other words, EFN’s underlying holdings are far removed from the derivatives debate in Washington; many of them generate much smaller percentages of their revenues from complex financial instruments and proprietary trading (see the EFN fact sheet).
Another interesting ETF for ex-U.S. exposure to the financial sector is the Global X China Financials ETF (CHIX). This ETF seeks to replicate the performance of the S-BOX China Financials Index, a benchmark that reflects the performance of China’s financial sector (see a list of all indexes covered by ETFs). There is some overlap between EFN and CHIX–both count several of the largest Chinese banks among their top holdings–with CHIX including some of China’s smaller financial institutions and EFN spreading holdings across a handful of economies.
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Disclosure: No positions at time of writing.