ETF Showdown: Two Wrongs Don't Make A Right

As the ETF industry has evolved, so have the number of emerging markets sector funds available to investors. Once upon a time, it was all about single-country funds or multi-country offerings like the Vanguard MSCI Emerging Markets ETF VWO. But EM sector funds have proliferated in a big way and that means there are funds that offer exposure to what is now a toxic brew: Emerging markets financials. European and U.S. banks have deservedly earned a bum rap over the past two years, but emerging markets banks have been no cup of tea in 2011 and there could be big problems on the horizon for Chinese banks as Benzinga noted earlier. To that end, now might be a good time to look at the composition of a couple of emerging markets ETFs focusing on the financial services sector: The iShares MSCI Emerging Markets Financials Index Fund EMFN and the EGShares Financials GEMS ETF FGEM. Home to 30 stocks and an expense ratio of 0.85%, FGEM is the older of the two funds and has $2.72 million in assets under management. With $5.67 million in AUM, the iShares MSCI Emerging Markets Financials Index Fund has an expense ratio of 0.67% and tracks 100 stocks. Those stats favor the iShares offering, but FGEM has a dividend yield of 4.4% compared to just 1.89% for EMFN. Despite the discrepancy in holdings, the top four country allocations for both funds are the same with China, Brazil, South Africa and India leading the charge. With EMFN the breakdown is 25.9%, 13.2%, 10.7% and 8.4%. For FGEM, it's 34.4%, 15.8%, 11.9% and 14.7%. EMFN offers exposure to six other countries while five others figure in FGEM's mix. There are also similarities among the top-10 holdings of both ETFs as Banco Bradesco BBD, Itau Unibanco ITUB, Bank of China, China Construction Bank, Industrial & Commercial Bank of China and Russia's Sderbank all figure prominently in each ETF. Not surprisingly, the year-to-date performance for both funds has been ugly with FGEM down about 25% and EMFN down around 21%. Simply put, both of these ETFs need a strong bull market for emerging markets stocks to flourish. Declining inflation wouldn't hurt either. While picking between these ETFs may feel like picking between a punch to the gut and a slap across the face, we're leaning with EMFN on the basis of superior liquidity and less exposure to Chinese banks. In addition, EMFN offers a higher allocation to Indonesia and weights to Thailand and the Philippines, which FGEM does not. Bull case: Emerging markets inflation wanes and ALL EM equities come back into style in a big way. Plus, it would help if the black clouds hanging over financials pass. Bear case: Investors keep up their healthy distrust of bank stocks regardless of home domicile. A Chinese banking crisis materializes and Europe's sovereign debt crisis worsens.