Inside The Europe ETF That Hasn’t Plummeted

by on May 6, 2010 | ETFs Mentioned:

Since the beginning of the year, most European equity ETFs have gradually sunk deeper and deeper into the red, as concerns about mounting government debts and ratings downgrades have rippled throughout the continent. Of the ETFs included in the Europe Equities ETFdb Category, all but two are in negative territory on the year, with some losing more than 20% year-to-date. But not all European investments have headed south this year; as profiled earlier this year, ETFs based on Nordic countries such as Sweden, Denmark, and Norway have bucked the trend, distancing themselves from their European neighbors and continuing attract investors (see Six ETFs To Watch As The Greek Drama Unfolds).

Focus on Euro Zone

The iShares MSCI Sweden Index Fund (EWD) was recently up about 3% on the year, while the Global X FTSE Nordic 30 ETF (GXF) has gained 1% in 2010. In contrast, the Vanguard European ETF (VGK) has lost about 11%, with several country specific ETFs—such as those focusing on Italy and Spain—losing more than 20%. So what’s driving such a big disconnect? Part of the explanation is rather simple.

Only 16 of the 27 members of the European Union (EU) have distinguished themselves as being members of the euro zone–EU countries that utilize the euro as their currency. While the common currency system has some major hypothetical advantages, recent months have highlighted a major vulnerability as well. While the fundamentals of European businesses have not necessarily deteriorated, lax fiscal policies in Greece—one of the smallest euro zone economies—have weakened the entire region. It’s no coincidence that the only two European ETFs in the black in 2010 have minimal euro exposure.

Sweden has recently declined replacing the krona with the euro, and it may come as no surprise that this Nordic country has shown higher growth and lower unemployment than the euro zone. Sweden’s decision to retain its own sovereign currency has drawn criticism in the past, but is looking more and more brilliant with each further decline in the euro. “Sweden may vote on the euro again, but is now likely to remain outside the euro zone for at least a decade,” writes Chris Morris.

The link between euro adoption and recent equity market performance is pretty clear. The iShares MSCI Spain Index (EWP) and iShares MSCI Italy Index (EWI) have returned -26% and -22%, respectively, in 2010.  The iShares MSCI EMU Index (EZU), which measures the performance of equity markets of EU members who have adopted the euro as its currency, has lost about 16% on the year. This suggests there is a direct correlation between euro adoption and equity market performance as the euro has just plunged to a one year low against the dollar.

Inside The Sweden ETF

EWD measures the performance of the Swedish equity market, tracking the MSCI Sweden Index. There are currently about 32 individual holdings in EWD, with the top ten accounting for nearly 65% of assets. The biggest allocations are to Hennes & Mauritz, Nordea Bank, and Ericsson (see the rest of the top ten holdings) From a sector perspective, EWD is relatively well diversified, with the largest allocations towards industrials (27.4%), financials (27.2%), and consumer discretionary (14.6%) sectors.

Returns and Fees

It appears Sweden may still have a little more fuel left in the tank. Even after BusinessWeek stated concerns last month that Sweden had forecasted inaccurate statistics which cost their government more than 600 kronor ($84 million dollars), EWD has continued to outperform other European ETFs. EWD has returned about 3% since the beginning of the year, putting it nearly 20% ahead of the Spain and Italy ETFs. EWD charges an expense ratio of 0.55%.

Tech Edge

Sweden’s status as one of the most technologically advanced economies has also given it an edge as companies become more in-tuned with global expansion and seek out locations that will make them technologically competitive. Annually, the World Economic Forum presents the Global Information Technology Report (GITR) that provides an accurate reading into the networked readiness of a country. The Networked Readiness Index (NRI) measures “the potential and degree of preparation of a community to participate in the Networked World.”

Although the index has flown under the radar for most investors in the past, this indicator can be useful in predicting possible arbitrage opportunities.  Soumitra Dutta, the Roland Berger Chaired Professor in Business and Technology at INSTEAD Business School, states that “many governments around the world have based their national technology deployment policies on the results and framework of this research.” According to the 2009-10 GITR, Nordic countries represent 4 of the top 10 economies, with Sweden topping the charts.

Despite recent news that the International Monetary Fund will aid in Greece’s recovery, uncertainty has continued to gather and downward pressure has continued to build on euro zone economies. For investors looking to gain exposure to European equity markets without taking on euro exposure, EWD presents an interesting option (also see EFA vs. HEDJ: A Better EAFE ETF?).

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Seth Dowling contributed to this article.

Disclosure: No positions at time of writing