Some emerging markets exchange traded funds have come under fire for not being diverse at the sector level. That criticism is often aimed at ETFs with excessive weights to the financial services sector so imagine the dangers of a dedicated emerging markets financial services ETF in the current market environment.
That is the life being currently being led by the tiny iShares MSCI Emerging Markets Financials ETF (NasdaqGS: EMFN). EMFN is down 8.2%, but for multiple reasons, that is arguably a decent performance given the circumstances but one that could easily deteriorate in the near-term.
China and Brazil combine for 40% of EMFN’s country weight with 28.6% going to China. The world’s second-largest economy is home to a massive, but opaque banking system. China’s banking system is big enough to cause serious global problems and some market observers are fearful of credit episode and/or shadow banking-driven event there. [China ETF Without the Banks]
There are signs of lending growth in Brazil, but reasons to be concerned as well.”Defaults between 15 days and 90 days, a gauge of the future behavior of delinquencies, rose 0.2 percentage points (in December) to 2.4 percent for companies and 0.1 percentage point to 6.3 percent for individuals,” Reuters reported.
The iShares China Large-Cap ETF (NYSEArca: FXI) and the iShares MSCI Brazil Capped ETF (NYSEArca: EWZ) have an average weight to the financial services sector of about 41%. The pair also have an average year-to-date loss of 11.4%. It is no wonder EMFN has trended lower and is vulnerable to further downside. [Emerging Markets ETFs Collapse]
EMFN and its constituents have also been hampered slack lending standards, which were employed to fight low interest rates abroad.
“Because emerging-market companies have been able to borrow so cheaply from foreign lenders, domestic banks had to find other customers. In other words, they had to lower their lending standards. A sharp run up in interest rates—which happens when central banks try to fight the currency slump by raising interest rates—could expose just how weak some of those borrowers were,” reports Matt Phillips for Quartz.
Exacerbating potential problems for EMFN and any emerging markets ETF laden with bank stocks are higher borrowing costs, which,as Quartz notes, could force developing world companies to withdraw their deposits making it harder banks to operate. [BIITS Rate Hikes Not Doing Much Good]
iShares MSCI Emerging Markets Financials ETF
ETF Trends editorial team contributed to this article.