Many investors have complained that the big three credit rating agencies in the U.S.–Moody’s, S&P, and Fitch– dropped the ball on the sub-prime mortgage crisis, and have questioned the independence of these agencies and the value of their ratings. Some contend that if these firms had been more diligent, they wouldn’t have given glowing ratings to securities that ultimately collapsed. Now there is a growing concern that a similar issue may be developing in regards to sovereign credit ratings. The three majors have been very slow to adjust their credit ratings for many European economies, often tweaking ratings after the crisis has reached an advanced stage. A similar situation is brewing in the heavily-indebted United Kingdom as well as the U.S.; both have AAA credit ratings but also have trillions in debt and low growth prospects for the foreseeable future.
Against this beckdrop a new firm in China, Dagong Global Credit, has compiled sovereign debt ratings for the 50 nations that make up about 90% of world GDP. Many of the ratings are markedly different than the corresponding marks that the countries receive from the U.S. big three. The U.S. rating is cut to AA, while Britain and France fall even further down to AA-. Meanwhile, other relatively strong economies such as Germany, the Netherlands, and Canada are also bumped down from their AAA ratings and given AA+ instead. One notable (but perhaps not surprising) gainer in this system is China, which rose to the AA+ level as well. Dagong says that it puts a higher weight on countries with “wealth generating potential” and those with large amounts of foreign reserves, something that is not a priority for American counterparts.”The reason for the global financial crisis and debt crisis in Europe is that the current international credit rating system does not correctly reveal the debtor’s repayment ability,” said Guan Jianzhong, Dagong’s chairman [also see Hardest Hit Europe ETFs From The First Half Of 2010].
The company also seems to be more bullish on Western nations with resource production potential such as Australia, New Zealand, and Norway, citing the rapid expansion of emerging markets as the ticket to growth for many developed economies in the near future. These emerging markets are not only growing quickly, but maintain low levels of debt and have massive foreign reserves that should sustain them in a future crisis. By some estimates, emerging nations hold three-fourths of all forex reserves, a fact that leads the firm to boost some of the surplus heavy nations in the ratings, such as China.
“For some emerging market economies, with the rapid economic development, the continuous improvement in both the institutional strength and the government fiscal conditions will inevitably bring about upgrading of their ratings,” Dagong said. “For some developed countries, due to the long-term stagnation of economic growth, there are obvious declines in their comprehensive institutional strength, and their fiscal conditions turn to be fragile. As a result, their positions in the credit rating sequence are to be adjusted downwards inevitably.”
Despite the downgrade of most Western nations–18 countries in total received lower ratings from Dagong than they did from the U.S. based firms–a few countries did manage to keep their golden AAA rating. Below we profile four ETFs that track some of the few able to achieve AAA status from this new Chinese credit rating agency.
One fund that offers significant exposure to the Nordic countries is the Global X FTSE Nordic 30 ETF (GXF). The fund, which tracks the FTSE Nordic 30 Index, includes the 30 largest and most liquid companies in Sweden, Denmark, Norway and Finland. Although Sweden and Finland were not ranked in Dagong’s initial report, it is likely that at least Sweden would receive a top rating; the country has been among the best performing economies in Europe over the past few months. By country, about 22% of GXF goes to Denmark, with another 15% to Norway. So far in 2010 the fund is up almost 5% and has added 12% over the past 52 weeks [also read Checking In On Two "Anti-Euro" ETF Plays].
Despite its lack of natural resources, Switzerland finds its way onto Dagong’s list of AAA rated countries due to its extremely stable political system, current account surplus, and low inflation rate. For investors seeking exposure to Switzerland, one choice is the iShares MSCI Switzerland Index (EWL). The fund offers investors access to 41 Swiss companies and is well diversified among a variety of sectors. Among the heaviest weightings are holdings in health care (30%), consumer goods (24%), and financials (20%). Some of the top individual holdings include food giant Nestle (21%), and two health care companies, Roche and Novartis. The fund is in the red in 2010, but has performed far better than most ETFs in the Europe Equities ETFdb Category [also see Switzerland ETF: Exposure To Europe's Bright Spot].
Singapore is an interesting choice for a AAA rated country given Dagong’s clear disdain for debt; the tiny city-state has debt as a percentage of GDP approaching 100% by some estimates. However, an extremely high current account surplus and absurdly high GDP growth figures–which recently hit a rate of 38.6%–are apparently enough to overcome concerns. For investors agreeing with the new agency, the iShares MSCI Singapore Index Fund (EWS) offers direct access to the dynamic Singaporean stock market. EWS has a heavy focus on financials, which make up more than half of total assets. The fund holds 33 securities in total and devotes almost all of its assets to large and giant cap companies; only 5.2% of total assets go to medium caps. Like much of southeast Asia, EWS has been roaring ahead lately [also read Looking For Green Shoots? Try Southeast Asia ETFs].
Although these countries have relatively high debt levels, they made their way onto Dagong’s triple AAA list by having large reserves in the form of in-demand commodities such as gold and coal. These resources will more than likely compensate for the higher-than-average debt burdens that the countries have, thus putting the two on the top tier. For investors seeking exposure to Australia, a popular choice is the iShares MSCI Australia Index Fund (EWA), which tracks the MSCI Australia Index. EWA is extremely focused on two sectors; financials (45%), and industrial materials (25%), while maintaining minimal allocations to technology and media firms. In terms of individual holdings, mining giant BHP Billiton takes the top spot with almost 15% of total assets [also see Warning: Five Country ETFs Heavily Focused On Financials].
Disclosure: Eric is long EWA.