It could be argued that much of the skill in investing lies not in finding brand new themes, but in devising clever variations of old ones.
One theme that is becoming old (and perhaps overbought) is the growing middle classes in the emerging markets buying huge new numbers of washing machines and cars. Less commonly observed is the fact that, to buy them, those middle classes will have to take out loans. Moreover, to have driveways and kitchens to put them in, they will probably have to start shouldering mortgage debt.
Financial services stocks are, therefore, potentially a great but still underappreciated way of tapping into the emerging market middle class, say analysts.
“Servicing the middle class is the most promising area for investors seeking massive growth within emerging market banking,” says Christine Schmid, co-head of global equity and credit research at Credit Suisse in Zurich. “It’s relatively underbanked because of its tremendous expansion. The developed-market banks, instead, concentrate on the ultra-high-net-worth segment.”
The key point at which individuals become considerably more attractive to financial services companies is when they join the so-called ‘mass affluent’ – people with between $100,000 and $1m in investable assets.
“Profits per customer rise by five or 10 times when customers move up from the mass market into this category, because they can be sold a wide range of high-value products,” says John Caparusso, head of bank equities at Standard Chartered in Hong Kong. These products include, he says, investment products and insurance.
Analysts say this is a hard group for developed-market banks to tap, with the exceptions, like HSBC (strong in Asia) and BBVA (building its wealth management in Latin America), proving the rule.
“In most countries it is the local banks benefiting from growing demand for financial services,” says Maarten-Jan Bakkum, emerging market strategist at ING Investment Management. “Local banks know their way round the system.”
Bakkum says that they have a better understanding of what regulators want from them, and are more in-tune with what local customers want, too. He cites Brazil, where local banks such as Itaú Unibanco have tapped into the growing mortgage market more successfully than foreign rivals.
Where are the most promising national markets in which to explore this theme?
India’s financial services growth is bolstered by strong structural factors, including a high savings rate, says Sam Mahtani, director of emerging market equities at F&C Investments. He says that the absence of a strong welfare system increases customers’ motive to seek wealth management services from banks and asset managers and that the growing size of the middle class is increasing India’s mortgage market by 16-17% a year. Mahtani cites HDFC Bank as an example of a well-managed local institution strongly placed to benefit, with a successful record in cross-selling the wide range of products that a middle-class household might want.
Another market that promises particularly strong growth in demand for financial services is Saudi Arabia, says Julie Dickson, equities portfolio manager at Ashmore. The government’s curbs on immigration have made it more difficult for companies to hire foreign rather than local labour, which Dickson says is contributing to the growth of a genuine middle class. Peru represents a third example.
“The government has done a reasonably good job of getting its economy on track”, says Dickson. “Moreover, it is less vulnerable to changes in commodity prices than in the past, and less exposed to them than its neighbour, Chile.”
Despite these enticing opportunities, investors might be forgiven for wondering whether an allocation to financial services in emerging markets sets them up for the same spectacular value destruction that befell their developed market financial stocks in 2007-08.
Mahtani thinks that portfolios can be positioned to avoid this. Taking the case of HDFC, for example, he says that the size of India’s mortgage market is still “extremely low” relative to the size of the economy and that, in any case, HDFC has a “very conservative” lending policy. Moreover, he argues that it is cheap, too, having dipped recently on emerging-market jitters that have nothing to do with the bank’s strong fundamentals.
Pension funds can also choose exposure that avoids the direct risk of collapsing loan books altogether, by concentrating on other, non-banking parts of financial services. Mahtani recommends AIA Group, for example. The Hong Kong-based company is one of the largest insurers in Asia. AIA is exposed to the high growth of economies in general, and of pension demand in particular, across much of Asia, including China and Indonesia.
“The middle class needs life assurance and pensions in Asia, because there is not a lot of state pension provision,” he says.
Given concerns about future credit problems, China, the biggest emerging market of all, presents a conundrum. The potential for middle-class banking services is huge. However, Bakkum of ING notes that China’s total government, corporate and household debt-to-GDP ratio has risen from 140% to 220% since 2008, an even more breakneck growth rate than that seen in developed markets in the five years leading to the 2008 credit crunch. Despite such concerns, Ashmore is overweight financial equities in China, arguing that it can manage the risks by avoiding banks with bad loan profiles.
There remains, however, a general sense of fear about potential financial sector imbalances in emerging markets – which is, ultimately, part of the broader fear about emerging market economic imbalances in general, which has caused period routs in emerging market stocks in recent months. Schmid at Credit Suisse notes that household and corporate lending in several countries with high current account deficits is based largely on credit from the international wholesale banking and financial markets. For example, banks in Turkey have issued several billions in dollar-denominated loans over the past two years.
This leaves local banks with funding gaps or, at the very least, more expensive funding, should international banks and investors grow fearful about whether the exotic emerging markets soaking up their capital will ever be able to repay it.
“Once local lending growth is no longer based on local deposit growth, the situation is potentially dangerous,” she warns.