Published August 21, 2013
When it comes to sector weights, emerging markets ETFs are usually heavily allocated to financial services, energy or materials stocks. Or some combination of those three sectors.
This is especially true of many of the largest most heavily traded single-country ETFs that offer exposure to developing world economies.
The reason is easy to explain. Many emerging markets ETFs are weighted by market capitalization and the largest companies in a broad swath of developing markets are banks or oil companies, often of the state-controlled variety.
While high oil prices have not been much help to ETFs with large energy sector allocations this year, just look at Russia funds, the woes being faced by emerging markets banks are even more concerning. Increasing levels of bad debt in some markets and slowing loan growth in others could spell bad news for these emerging markets funds.
iShares MSCI Turkey ETF (TUR) The iShares MSCI Turkey ETF is one the poster children for the problems currently faced by a plethora of emerging markets funds. Not only is the formerly high-flying TUR vulnerable to Federal Reserve tapering, but the fund could be exposed to shocks within Turkey's credit market.
Turkey's recent economic boom was, in large part, fueled by its formerly strong lira and the previously weak U.S. dollar. That allowed Turkish corporate borrowers to borrow U.S. dollars at favorable rates to fund new real estate projects. Now the lira is weak and the dollar is strong. Dollar loans in Turkey are around $172 billion represent 22 percent of the overall economy and Goldman Sachs is forecasting a dollar-lira rate of 2.2, representing a 15 percent mini-devaluation from the current level of 1.95, according to the New York Times.
That is not good news for an ETF like TUR that allocates nearly 47 percent of its weight to the financial services sector, more than triple its weight to industrials, the ETF's next largest sector weight.
Indonesia ETFs The iShares MSCI Indonesia ETF (EIDO) has a 35.4 percent weight to financials. The Market Vectors Indonesia ETF (IDX) devotes 34 percent of its weight to the same sector. Last week, Bank of Indonesia, the country's central bank, raised the secondary reserve requirement for lenders to 4 percent from 2.5 percent while dropper the loan-to-deposit ratio to 78 percent to 92 percent from 78 percent to 100 percent. The latter move can be seen as tighter policy.
A widening account deficit and weak rupiah are among the unfavorable factors weighing on Indonesia ETFs. However, while central bank policy may be seen as tight some global investors are concerned that BoI missed a chance to raise interest rates last week.
Making matters worse for these ETFs is that domestic consumption, previously part of the bull case for Indonesia, has dipped a bit because consumers are already heavily indebted. These factors leave little room for near-term loan growth.
Russia ETFs Russia ETFs are energy-heavy, but the Market Vectors Russia ETF (RSX) has an 11.8 percent weight to financials while the rival iShares MSCI Russia Capped ETF (ERUS) features an almost 17 percent allocation to the same sector.
Russian loan growth has held up well compared to other parts of the developing world, but there are signs of a slowdown. That is usually the byproduct of high interest rates and Russia has some of the highest in the emerging world. Russian banks are demanding more collateral and charging small businesses rates that many of those business simply cannot afford, mean the loans do not get made.
With banks a pivotal part of President Vladimir Putin's higher dividend plan, that plan could suffer if loan growth at Russian banks stagnates.
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Disclosure: Author owns none of the securities mentioned here.
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