Should You Consider The Emerging Market Financial ETFs?

by on September 5, 2011 | Updated September 6, 2011 | ETFs Mentioned:

The past few weeks have been an extremely rough period for financial companies in the U.S. as worries over the economic situation continue to mount. Concerns are building that not only will major financial institutions face another mortgage crisis thanks to an extremely low level of job growth, but also that ghosts from the last crisis may still be haunting some of the nation’s largest banks as well. In fact, federal housing authorities have joined in the wave of lawsuits targeting banking institutions, saying that these companies allegedly misrepresented the value of mortgage-backed securities, further adding to the woes for the sector. “The financial sector performance has been a real laggard to say the least,” said Brian Gendreau, a market strategist at Financial Network. “These lawsuits certainly do not clear up the uncertainty.”

Meanwhile, in Europe the situation isn’t much better as a number of financial institutions teeter on the brink with only the combined weight of some of the world’s largest economies keeping them afloat. Worries are also building that some of the highly indebted PIIGS nations may be heading for a default and that significant bond haircuts are in the future for many financial institutions, a situation that could plunge the continent into a fresh crisis. Ten year bond yields are already above 5% in both Italy and Spain, while the smaller economies of Portugal and Greece both have double-digit rates for their comparable debt, further suggesting that the pain may just be beginning for this troubled region of the world [see all the European ETFs here].

Yet, with all the turmoil in developed markets, many of the world’s emerging nations are chugging along relatively unscathed. Banks in these countries have low levels of exposure to euro zone debt and did not really participate in the American housing debacle, leaving them in a prime position heading into the winter. Furthermore, banks in these countries are often focusing in on citizens that are using credit for the first time, have solid balance sheets, and are generally underexposed to financial products, allowing for high levels of growth for years to come [see all the Emerging Market ETFs here].

In light of this bifurcation between the developed and emerging worlds, investors may be wise to take a closer look at broad-based ETFs that offer exposure to this region of the world in order to still maintain holdings to financials but with lower levels of risk. Below, we highlight two quality choices for investors seeking to avoid developed market financials and instead, focus in on emerging market banks, credit providers, and real estate firms in a single, exchange-traded ticker:

iShares MSCI Emerging Markets Financials Sector Index Fund (EMFN)

This fund tracks the MSCI Emerging Markets Financials Index which is a free float-adjusted, market capitalization-weighted index designed to measure the combined equity market performance of the financials sector of emerging markets countries. Component securities include those of banks, diversified financial companies, insurance companies, and real estate companies. EMFN holds about 100 securities in total with roughly 75% of exposure going to banks with the rest divided up evenly between insurance, real estate, and diversified financials. In terms of individual country exposure, financial institutions from China make up close to one-fourth of the total while companies in Brazil (14%), South Africa (9.2%) and India (8%) also take up big chunks as well [see charts of EMFN here].

EGShares Financials GEMS ETF (FGEM)

This product is slightly older than EMFN but recently underwent a name change to become a part of the GEMS suite from EG Shares. This product, like the rest of the GEMS, seeks to give investors exposure to 30 of the largest companies in each of the major market sectors. In this iteration, FGEM offers investors exposure to a variety of banks and other financial institutions that are based in emerging markets around the world. Top individual holdings go to Brazilian companies Banco Bradesco and Itau Unibanco Holding, while Asia’s top holding goes to the Industrial & Commercial Bank of China. In terms of specific country allocations, China dominates the list with close t0 40% of total assets although Brazil, India, and South Africa make up double digit allocations as well [see more info on FGEM's fact sheet].

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Disclosure: No positions at time of writing.