New Financial ETF Sinks or Swims With China

NEW YORK ( TheStreet) -- EG Shares' newest exchange traded fund, the EG Shares Dow Jones Emerging Markets Financials Titans Index Fund ( EFN), focuses primarily on so-called BRIC countries, where rising middle classes are enriching banks and insurers.

China carries the largest weighting, at 42%, followed by Brazil, with 22%, and South Africa and India, at 9% each. Similar to the company's other funds, the newest ETF concentrates holdings in a few stocks. The biggest positions are Industrial & Commercial Bank of China ( IDCBY) and Brazil's Itau Unibanco ( ITUB), each at 9.1%, and China Life Insurance ( LFC), with 8.5%.

The Dow Jones Titan indexes are market-cap weighted. Itau Unibanco has a market value of $84 billion, and China Life comes in at $49 billion. Those are smaller than mega banks in the U.S. and Europe. Still, the indexes will be BRIC-heavy for a long time as large banks in other countries are much smaller than, say, many Chinese financials. It just so happens with the financial fund that the banks from Russia don't make it on to the list of largest publicly traded financial stocks, but most of the other EG Shares ETFs will have quite a bit of exposure to Russia.

The biggest risk with the fund is its heavy exposure to China. In the past few months, there has been a lot of attention paid to the amount of loan growth in China. In November, limits on lending were lifted to support China's stimulus package, and the pace of new loans skyrocketed as a result, sparking concern of a financial bubble in China. (Sound familiar?) Central bank officials have said publicly that loan growth will stabilize. So is the problem solved? Well, that's the question -- as well as the biggest challenge for fund holders beyond the normal increase in volatility that goes with investing in emerging markets.

There are a couple of compelling catalysts in favor of the fund. Clearly, growth prospects for the emerging world are very good, certainly better than for the U.S. or Europe over the next few years. If that promise is to be fulfilled, local banks will finance those prospects, and the local service companies (insurers and investment houses) will benefit from a new middle class.

Additionally, those markets, and by extension emerging-market financial companies, aren't dependent on a recovery in the U.S. If the U.S. is as bad off as people fear, it makes sense to expect it will be a long time before American financials are fundamentally healthy, which makes them less-than-ideal investment candidates.

Brighter prospects won't make emerging-market sectors any less volatile. Investors in this space need to be prepared for bigger cyclical moves in both directions. And if Chinese officials can't stabilize lending, the EG Shares Dow Jones Emerging Markets Financials Titans Index Fund will likely get hit pretty hard.

At the time of publication, Roger Nusbaum had no positions in the securities mentioned.

Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.

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