A Sustainable Growth Opportunity: Financial Formalization

The Financials sector tends to be a challenging one for investors seeking quality and sustainable growth. Neither attribute features prominently in this space and finding the two together is rare. Perhaps unsurprisingly, our exposure to Financials versus our primary benchmark, the MSCI ACWI ex US Index,1 has consistently been among our largest sector underweights. The challenges of Financials, however, do not make the sector un-investable for sustainable growth investors. This is because well managed investment candidates may avoid risks common to most Financials while harnessing a multitude of secular growth themes, particularly in the retail market within emerging economies. Among the strongest of these themes is one we called Financial Formalization.

Financial Formalization is a combination of two secular themes most commonly observed in emerging markets: (1) rising financial inclusion, which sees more people entering the formal financial system; and (2) deeper financial penetration, which sees people already within the formal system utilizing it more fully (see Figure 1). The balance of these two trends varies by country, as does the mix of macro enablers, which can include rising per capita GDP and wealth, low credit penetration, and favorable demographics.

Figure 1: Financial Inclusion & Penetration Is A Growth Opportunity In Many Emerging Markets

India Versus China

India is similar to other emerging markets in having its fair share of challenges. These are broad and encompass economic, financial, social, and environmental issues. Despite its challenges, India is well on its way to surpassing China as the most populous country on earth, and with more favorable demographics: nearly 45% of Indians are under 25 years old versus less than 30% of Chinese. Furthermore, India’s youthful population has many years to grow into the country’s rising demand for labor, whereas China’s aging population─thanks to its past “One Child” policy─is expected to create a labor bottleneck within a decade (see Figure 2). India also presents investors an economy early in its development with vast capacity to support wealth creation and the burgeoning of several industries, financial services being one. For example, India’s population approaching 1.4 billion is comparable to China’s, yet India’s GDP of $2.7 trillion in 2018 was one fifth that of China. Similarly, only around 9% of India’s population is seen as middle class versus approximately 67% in China (middle class defined as those with a net worth between $10,000 and $100,000). (Source: Credit Suisse Research Institute Global Wealth Report 2018)

Figure 2: India's Demographics Are Superior To Many Other Countries, Including China

Indian Financials: A Wealth of Sustainable Growth Opportunities

With a youthful populous still far from approaching middle class status, India is at a nascent stage of penetration in most consumer financial products. We believe this opportunity is greatest in lending and savings products including mortgages, credit cards and personal loans, asset management, and insurance. The penetration of retail mortgages – by far India’s most advanced retail credit product – is just 10% of nominal GDP versus 26% in China, 32% in Malaysia, 50% in the US, and almost 100% in some European countries. Overall household debt as a percentage of GDP in 2017, as illustrated in Figure 1, was less than 11% in India, among the lowest of all emerging markets, versus 49% in China. This underscores how mortgages represent the vast majority of retail lending in India, with most other products at a truly nascent stage. Indeed, only 0.02% of the population in India has a credit card. (Sources: Housing Development Finance Corporation Limited, August 2019; International Monetary Fund household debt to GDP data as of 2017; J.P. Morgan 2019 Payments Trends – Global Insights Report)

Rural India, the heart of its financial inclusion opportunity, is beginning to see benefits from recent infrastructure investments in roads, plumbing, electricity, and mobile telephony. The Modi government has also enacted measures that should increase Financial Formalization, including demonetization, introducing a biometric version of a social security number (called Aadhaar which means “foundation” in Hindi), and mandated low-cost bank accounts for all (Pradhan Mantri Jan Dhan Yojana or PMJDY). These investments should support economic growth, particularly via more effective benefits distribution, ecommerce, and digital payments. Technological advancement should also enable more savvy financial companies to enlarge their addressable market and capture this opportunity at scale without having to build branches in areas with low population density.

These private sector players should also be well-positioned to continue gaining share from the Indian public sector banks, which collectively control as much as 75% of the market and are mostly inferior operators. At a portfolio level, India tends to be fairly uncorrelated to major regional equity markets and is, therefore, a source of diversification.

Dodging Risks

Investing in financials, regardless of country, necessitates a keen focus on risk management at the stock level. This is accentuated in emerging markets because they tend to be more vulnerable to exogenous shocks. Among other things, one must invest behind only the most honest and able management teams since leaders of financials have undue influence over their company’s future via the culture and incentives set around balancing growth versus risk.

Fragmented markets should generally be avoided but, in the case of India, the consolidation of its fragmented financial system should be beneficial to best-in-class operators. Investment candidates must also possess a strong balance sheet in terms of the quantity and quality of liabilities and equity, which provides a buffer against external shocks and flexibility to capitalize on the weakness of others.

An Opportunity for Sustainable Growth Investors

Our research indicates that only a low single-digit percentage of all international stocks with a market capitalization over $1 billion meet the inclusion factors of our investment philosophy. We feel that it is especially challenging to find high-quality sustainable growth companies within the Financials sector. Nonetheless, we have identified a number of financial companies harnessing Financial Formalization that meet the inclusion factors of our investment process. Such companies have delivered above-average earnings growth at attractive returns on equity, which our analysis indicates should persist over our long-term investment horizon.


Comparisons to a financial index are provided for illustrative purposes only. Comparisons to the index are subject to limitations because portfolio holdings, volatility and other portfolio characteristics may differ materially from the index. Unlike the index, portfolios within the composite are actively managed and may also include derivatives. There is no guarantee that any of the securities in the index are contained in the portfolio. The performance of the index assumes reinvestment of dividends but does not reflect the impact of fees, applicable taxes or trading costs which, unlike the index, may reduce the returns of the portfolio. Investors cannot invest in an index. Because of these differences, the performance of the index should not be relied upon as an accurate measure of comparison.



The MSCI All Country World ex-US Index (the “MSCI ACWI ex-US Index) is a market-capitalization-weighted index maintained by Morgan Stanley Capital International (“MSCI”) and designed to provide a broad measure of stock performance throughout the world, with the exception of U.S.-based companies. The MSCI ex-US Index includes both developed and emerging markets.