Emerging markets financials: why we see opportunities
- Emerging markets are unbanked: low credit penetration and almost a billion citizens without bank accounts offer room for growth;
- Digitization, fintech and mobile/cashless payments are changing the banking sector in emerging markets and penetrating the millions of unbanked citizens in underserved communities in countries like China and India;
- The growth of digital banking is creating opportunities for non-traditional IT companies to enter the financial sector, build popular products and exploit growth opportunities;
- Financial services subsectors, like insurance, have solid fundamentals and have room for growth as populations age and citizens demand better coverage.
As emerging markets (EM) drive the world economy, investors can find attractive sectors within EM, like consumer and information technology, that are being driven by long-run fundamental trends.
Financial services is one other, and we have been structurally overweight to this sector vs benchmark for some time now. We base our conviction on wide-ranging factors, but four stand out.
1. Room to grow because EM look unbanked
Many EM are 'unbanked' because their financial sectors are small compared to the size of their economies.
Credit penetration, measured by total domestic credit to the economy from the financial sector as a % of GDP, can gauge how unbanked a country is.
World Bank data2 show low credit penetration in many EM countries, and certainly compared to more developed nations.
This indicates scope for financial services to grow because low credit penetration creates space for expansion even in the absence of economic growth.
However, low penetration is not the only determinant of financial sector growth. Other factors, like availability of liquidity, recent credit growth, and cost of risk, are also important. Also, attractiveness very much depends on respective markets, regulations, and management3.
Exhibit 1: Credit Penetration (Credit as % of GDP, Y-Axis) vs GDP per Capita (USD – PPP, X-Axis)
2. Market opportunity: almost a billion people in EM don't have bank accounts
The number of unbanked customers in EM amounts to a sizeable opportunity.
948.2 million people in EM don't have bank accounts, according to World Bank financial inclusion surveys5 and United Nations6 data.
We believe that as EM economies grow, urbanization expands, and more people are brought into formal employment, demand for financial services, like bank accounts and loans will increase and a lot of this demand will come from millions of unbanked citizens being brought into the banking sector.
Exhibit 2: EM: No. of People Aged 15 Years+ But Without Bank Account (Millions), 2017
3. Huge potential from digitization
While the size of the market and space for growth are large, the question of how financial companies grow their businesses is also vital, and we believe digitalization of financial services will be a key driver.
Digitization means using technology to provide services, such as online banking, and making banking processes, like loan applications, more efficient.
And the building blocks for digitalization are well and truly in place in EM.
Growing smartphone usage is one aspect. For example, total smartphone users in India is expected to grow from 279.2 million in 20187 to an estimated 829 million in 20228.
Expanding internet access is also an area where EM have seen massive growth: for example, in 2007 there were 527 million EM internet users, compared to 2.2 billion at the end of 20179.
Demographic trends are also important. EM have an estimated 2.1bn citizens aged below 30, accounting for 57.2% of citizens aged below 30 globally10.
That's important because this demographic are more 'tech-savvy' than older generations and are likely to be fast adopters of new technology.
What cashless payments can tell you about EM
The explosion of cashless payments in China is a case in point.
High smartphone usage, expanding internet user access, tech-savvy early adopters, plus a range of innovative platforms have created an ecosystem that handled USD 41.5 trn of mobile payments during 201811.
Exhibit 3: China: Mobile Cashless Payments (USD Trillions), 2014-2018
And banks are using digitization to expand in new markets.
HFDC Bank in India has grown its business by building online infrastructure and one-man branches and expanding into relatively underpenetrated rural areas, connecting with many small companies and rural Indians by extending banking and small loans services.
4. Strong demand prospects for financial services, like insurance
Looking at subsectors of financial services, insurance has good growth prospects.
Two key drivers stand out:
- Ageing populations: EM countries will have 770 million citizens aged 65 years+ in 203512, which means a large market for health insurance and pensions.
- Inadequate social safety nets: social safety nets in many EM remain inadequate to meet the needs of citizens, so many citizens are shifting to private companies.
Levels of insurance penetration in EM are low, which indicates room to expand as incomes rise and the above drivers play out.
Exhibit 4: Insurance penetration (Total gross premiums as % of GDP), 2017
Industry estimates forecast that Emerging Asia, MENA, Latin America, SSA will deliver the fastest growth in both life and property & casualty insurance in the coming years.
Property & Casualty and Life Insurance, Forecast Premium Growth (% - CAGR, 2018-2030)
But the digitization of financial services growth in the sector may not be limited to traditional insurance companies.
Tech companies may capture some of the growth potential in the insurance sector by offering insurance products on their platforms.
One instance could be the case of Ant Financial, a Chinese fintech company affiliated with Alibaba, which recently began offering health coverage plans on Alipay for RMB 188 per month.
Putting it all together
For investors, these four factors amount to compelling reasons to be positive on the outlook for long-term growth in financial services sectors in EM.
But successfully investing is not as simple as picking the biggest financial companies in EM. EM are a highly heterogenous space, with significant variations between countries, so a nuanced approach is necessary.
Additionally, non-traditional financial services companies, like online platforms and leading IT names, are rapidly developing financial products and services and, in many cases, have taken the lead in new tech-driven financial channels.
So we continue to be selective, basing our views on research trips throughout EM from which we build an 'on-the-ground' perspective to guide our investment process.
These perspectives, coupled with judgments on company quality, industry drivers, ESG standards, and top-down macro trends, have driven our long-term performance, and we believe our tried and tested approach means we will continue to invest well in EM.