ETF eurozone tremors

The eurozone paints a mixed picture as speculation mounts about the future of the single currency. Nick Sudbury reports

Last year was a tumultuous one for the EU with Greece and Ireland both needing substantial bailouts. The extra capital may have done the trick for now, but fears that Portugal, Spain, Italy and possibly Belgium could follow suit means that a break up of the euro remains a distinct possibility.
If the single currency is to survive in its current format the weaker peripheral countries will need to undergo years of austerity measures to get their deficits back under control. Failure to do so would require the stronger economies in the German-dominated core to continue to subsidise their more profligate neighbours.
Until the situation is resolved, returns across the eurozone sector are likely to remain highly volatile. This suggests that investors should tread carefully when deciding which ETFs to use to build their exposure.

Survival of the fittest

In spite of the recent problems the sector is home to some impressive long-term performers with the top five ETFs all managing to generate five-year returns in excess of 50%.
Leading the way is the iShares MSCI Sweden index with a gain of 77.69%. This US-listed ETF has a total expense ratio (TER) of 0.53% and assets under management of $432m. It currently has a portfolio of 35 holdings with an overall PE ratio of 20.32 and a dividend yield of 2.32%.
Sofia Antropova, sales strategist for iShares in Europe, says that Sweden bounced back more quickly than other similar countries due to strong public sector finances and a reliable export-driven economy. 
“MSCI Sweden is heavily invested in industrials, consumer discretionary, information tech and telecomm services with a total of 65% of the index exposed to these areas. The ETF has been performing in line with the index and over 2010 the tracking error was just 0.19%.”
Three of the top five-year performers are all linked to Germany. They are the iShares Dax, which is up 61.7%, the iShares DivDax with a gain of 53.07%, followed by the 50.44% achieved by the iShares MSCI Germany index ETF.
The iShares Dax invests directly in the 30 largest and most traded stocks listed on the Frankfurt Stock Exchange, whereas the DivDax offers exposure to the 15 of these companies with the highest dividend yields. MSCI Germany is more diversified with 50 holdings.
Antropova makes the point that Germany is one of the world’s largest exporters with approximately 40% of exported goods and services. “Recent eurozone sovereign credit events undermined the strength of the euro in 2010. This had a positive effect on the performance of the German economy, especially as measured by the Dax.”

Weak euro

The recent problems in the eurozone have taken their toll on the three-year performance figures with only two ETFs in the sector making double digit returns. Again the iShares MSCI Sweden index tops the table, with the nearest rival to its gain of 44.72% being iShares MSCI Switzerland, which is up 31.05%.
Both of these countries are in a strong financial position and this has allowed their currencies to appreciate on the foreign exchanges. Over the last three years a UK-based investor with money in Swiss francs would have enjoyed a 33.5% gain just from the FX exposure. Those with an investment denominated in Swedish krona would also have seen a significant return.
Holders of the Global X FTSE Nordic 30 ETF have benefitted from the same trend. This US-listed product was launched in August 2009 and is up 28% in the last year. It provides investors with exposure to the largest and most liquid companies in Sweden, Denmark, Finland and Norway.
Evelyn Hu, vice president of Global X Management, says that these countries have stable economies and all have the highest AAA credit rating. “Historically the Nordic region has produced higher returns than its neighbours. Sweden is the largest country in the fund, with 45.3% of the weighting, followed by Denmark at 19.5%, Norway at 17.3% and Finland at 16.7%.”
The currency markets have also had a huge impact on returns from all of the other ETFs in the sector. During the initial stages of the credit crisis the euro was seen as a safe haven, which enabled it to get close to parity with the pound. This trend began to reverse at the start of 2009 and since then the problems in Greece and Ireland have rendered the exchange rate extremely volatile.
Over the last five years UK-based investors would have made a 23.1% gain purely from exposure to the euro, while a three-year holding would have appreciated 15.2%. Of late the trend has been much more volatile with a 12-month investment suffering a 4.8% loss on the currency markets.

Irish bailout boosts sentiment

The €85bn bailout of Ireland in November has restored a measure of confidence to the European equity markets. This has enabled many of the ETFs in the sector to produce some excellent short-term returns.
ETFs linked to Germany have done especially well, with  leveraged products being the main beneficiaries. In the last three months the ETFX Dax 2x Long Fund is up 26.92%. Lyxor ETF LevDax has risen 27.72%, while the db x-trackers LevDax Daily ETF has gained 26.62%.
The latter of these is listed on four different exchanges and is available in a variety of different base currencies. In each case the daily return is calculated as twice the movement in the Dax index minus the borrowing costs associated with the leverage.
Manooj Mistry, head of db x-trackers UK, says that the LevDAX ETF provides exposure to a leveraged index that resets on a daily basis. “In effect it locks in the performance at the end of each day and then compounds the daily performance figures across the period that the position is kept open.”
The advantage of this type of product is that it allows investors who want to take short-term leveraged positions without having to use derivatives. This means there is no need to worry about rollover costs or margin calls.
Mistry makes the point that the performance of their leveraged ETFs is more complex than a regular, non-leveraged ETF, which means these products are more suited to sophisticated investors who understand how the leveraged index works.