Healthy Banks Could Boost Indonesia ETFs

A dichotomy is presented to ETF investors when they opt to evaluate a fund that has a large portion of its weight in just one sector or a one or stocks. That dichotomy is excessive weights to a single sector or a small number of stocks can work, but not forever. Just ask those that got stuck holding ETFs with heavy Apple AAPL exposure. Excessive sector weightings are particularly prominent among emerging markets ETFs and the alarmingly high allocations usually go to one or some combination of the following three sectors: Energy, financial services and materials. For example, the iShares FTSE China 25 Index Fund FXI is often maligned for its large weight to Chinese banks, currently almost 60 percent. The iShares MSCI All Peru Capped Index Fund EPU is not the place to be for investors looking to avoid materials stocks because that sector represents almost 49 percent of EPU's weight. All that said, there are signs that two emerging markets ETFs tracking the same country could benefit this year from large allocations to bank stocks. Those funds are the iShares MSCI Indonesia Investable Market Index Fund EIDO and the Market Vectors Indonesia ETF IDX. IDX, the older of the two largest Indonesia ETFs, has an almost 30 percent weight to banking names. EIDO's weight to the same sector is north of 34 percent. For now, those large weights to banks could serve EIDO and IDX because Indonesian banks have emerged as a leadership, having helped lift the Jakarta Composite Index to an all-time high during Friday's Asian session. Indonesian, Indian and Philippine lenders are the most attractive and feature the "highest next-12-month banking sector performance" among emerging Asian financial services firms, Bloomberg reported, citing a note from BernsteinResearch. During Asian trade Friday, a strong earnings report lifted Bank Rakyat almost two percent to its best close since November 2003, according to Bloomberg data. Rivals Bank Negara Indonesia, Bank Mandiri Persero and Bank Central Asia soared 8.3, five and 3.6 percent, respectively. In the case of Bank Mandiri and Bank Central Asia, those stocks moved to all-time highs. Bank Central Asia, Bank Rakyat and Bank Mandiri are three of IDX's top-five holdings with Bank Negara found further down the ETF's roster. Combined, the quartet equals 23 percent of IDX's weight. The first three names also represent three of EIDO's top-five holdings. In that fund, Bank Central Asia, Bank Rakyat and Bank Mandiri combine for 23.1 percent of the total weight. Friday's bullish trade had good reasons behind it. On Monday, Moody's Investors Service placed a stable rating on the Indonesian banking system, saying it "will remain stable for the next 12-18 months." "We expect 6 per cent GDP growth, 20 per cent loan growth and low credit costs in 2013. These trends will protect the Indonesia banks' strong capital generation capacity," according to the ratings agency. Fitch Ratings also announced a stable outlook for Indonesian banks on Wednesday. Fitch conducted a "stress test" of the nine major Indonesian banks and found those banks would incur loan losses, on average, of 3.8 percent in a downward cycle, but that those losses would be easily covered by pre-loss provisions. Adding to the bull case for IDX and EIDO is the impressive Tier 1 capital ratios being sported by Indonesian banks. "The combined Tier 1 capital, which is composed entirely of high-quality common equity, of these banks stood at an average 14% of risk-weighted assets at end-H112," according to Fitch. By comparison, J.P. Morgan Chase's JPM Tier 1 capital ratio was 8.4 percent at the end of September 2012, Fitch noted. Bank of America's BAC was 8.97 percent, the ratings agency said. For more on ETFs, click here.