Editor’s Note: Benjamin Shepherd and I work together on Global ETF Profits, an advisory focused on using exchange-traded funds (ETF) to profit from key short- and long-term trends.  

With the right strategy, ETFs can be a very powerful addition to you asset-allocation arsenal.

In today’s issue of Emerging Markets Speculator, Benjamin offers an easy way to gain broad exposure to one of the most promising long-term investment themes: emerging markets financial institutions.

Profit from International Banking

By Benjamin Shepherd

In a 2005 speech to the Virginia Association of Economics, Federal Reserve Chairman Ben Bernanke coined the term ‘global savings glut’ to describe the phenomenon of rising national current account surpluses in both industrialized and emerging economies.

Although the US and its citizens can hardly be described as thrifty, households in other countries have exhibited a propensity to put excess earnings aside for a rainy day or to ensure a more comfortable retirement.

This inclination to sock money away was problematic, slowing investment and hampering growth in many parts of the world. It also created a huge reliance on foreign investment to develop local markets.

But these attitudes are shifting. Data from supranational organizations such as the Organisation for Economic Co-operation and Development shows that although the savings rates in many nations continue to rise, a growing portion of that money is finding its way into productive investments rather than mattresses.

The rise of the sovereign wealth fund is emblematic of global governments’ willingness to deploy currency reserves. Rather than leaving current account surpluses sitting on a ledger sheet, these funds are deployed in both international investment and domestic development to buffer against tough economic circumstances.

This phenomenon has also translated to the consumer side; savings are being deposited into a plethora of international banking institutions, as well as mutual funds and other investment vehicles.

This creates a huge opportunity in exchange-traded funds (ETF) that focus on the global financial sector, which is enjoying rapid growth from both the growing international middle class as well as a growing distrust of the Western financial sector.

iShares MSCI Emerging Markets Financials Sector Index (NasdaqGM: EMFN) is one fund that will benefit.

Although most Western banks have stagnated in the wake of the credit crisis, banks in developing markets are well capitalized and eager to move into the markets abdicated by Western players. After the massive market realignment, developing market banks now account for about half of the global banking industry.

Domestic players in emerging markets also have home-field advantage as the ranks of the middle class–the traditional bread and butter of bankers–swell, particularly in India and China. And the middle class in developing economies traditionally have been underserved.

That sets the stage for explosive long-term growth as maturing financial institutions gain the confidence of the banking public. They’ll also have an advantage because banking regulation operates differently abroad. In the US, bank regulation is rigid and rule-based; most regulations in developing nations are policy-based, affording a degree of flexibility.

That’s particularly true in India, which accounts for 7.6 percent of the ETF’s investable assets. The fund’s two major Indian holdings are HDFC Bank (NYSE: HDB) and ICICI Bank (NYSE: IBN). Both banks offer retail banking services to a growing segment of the population and do a robust corporate business, in addition to trading their own accounts.

Unlike in the US, where strict limits are likely to be imposed on proprietary (prop) trading, the prop desks at international banks aren’t in danger and offer large profit centers.

The fund also has substantial exposure to Brazil, South Africa and South Korea.

The fund’s single largest national exposure–and greatest risk factor–is China, which accounts for more than 30 percent of assets. On the one hand, holdings such as China Construction Bank (HK: 939), Industrial and Commercial Bank of China (HK: 1389) and Bank of China (HK: 3988) are the nation’s leading banks and enjoy clear governmental support.

On the other hand, the Chinese government sets lending targets that the banks must meet. Although a high degree of government involvement hasn’t led to any major blowups, it’s widely believed that it could lead to a sharp deterioration of lending standards. Still, China represents one of the fastest-growing markets for banks.

Benjamin Shepherd is editor of Louis Rukeyser’s Mutual Funds and co-editor of Global ETF Profits.