If you were to ask a group of long-term investors about the preference for the exchange-traded structure over traditional actively-managed mutual funds, the response would be fairly predictable: lower costs mean higher bottom line returns, especially when compounded over a relatively long time horizon. But while ETFs may have been created with the buy-and-holder in mind, it is now clear that these products have been embraced by active traders as well (see Five Surprising ETF Turnover Stats).
And while these active investors no doubt appreciate the lower costs, it is the other unique aspects of ETFs that have attracted them to these securities, including the intraday liquidity and ability to sell short. Because investors are able to establish both short and long positions in ETFs, the number and complexity of strategies accessible through these securities is significantly higher than what would be available in a mutual fund-only portfolio. Shorting isn’t for everyone–the potential for unlimited losses and bet against the market requires an above-average risk tolerance–but it can allow investors to profit from short-term imbalances and generate positive returns even in bear markets (see ETFs vs. Mutual Funds).
There is no shortage of bearish sentiment in the current environment, particularly surrounding European markets. With Greek debt now officially in junk status, cash-strapped governments across the continent are introducing austerity measures designed to stave off a wave of sovereign defaults. Many investors are worried that the tough talk from euro zone governments is too little, too late. “Only time will tell if we are past the worst of the debt crisis in Europe, or simply enjoying a calm amidst the storm,” writes Stephen Simpson. “In either case, the crisis in Greece and the fears of its spread into Spain, Italy and Portugal have led many financial analysts and commentators to seriously consider what had once been mostly the domain of crackpots – the notion that the euro could collapse and vanish altogether.”
For investors looking to bet on a further deterioration of Europe’s fiscal health and sustained slide in equity markets, short exposure to the region through an ETF is an interesting option. Below, we profile three ETFs that figure to struggle in coming months if turmoil in Europe continues [see Free Report: How To Pick The Right ETF Every Time].
- iShares MSCI EMU Index Fund (EZU): This ETF tracks the MSCI EMU Index, a benchmark designed to measure the performance of equity markets in EU countries that have adopted the euro as the currency. With the survival of the common currency in doubt, many investors have developed a case of “euro aversion,” seeking to steer clear of any euro-denominated assets. If downward pressure on the euro remains, expect EZU to continue to lag other funds in the Europe Equities ETFdb Category.
- iShares MSCI Europe Financials Index Fund (EUFN): This ETF offers exposure to financial institutions across Europe, and has been one of the hardest-hit funds in recent months. Exposure to suddenly-risky sovereign debt is weighing on these banks, and the ability of debt-laden governments to support financial institutions has been called into question recently. If Europe’s woes continue, expect financials (and EUFN) to lead the way down [see Actionable ETF Trading Ideas].
- WisdomTree Europe SmallCap Dividend Fund (DFE): While most Europe ETFs focus on mega-cap companies, DFE offers exposure to smaller European stocks. This distinction is an important one; whereas the components of VGK generate revenues from around the world, DFE’s constituents depend on growth in domestic consumption. As such, this ETF is more of a “pure play” on the local European economy, and may more accurately reflect changes in the region’s economic prospects (see Guide To International Small Cap ETFs).
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Disclosure: No positions at time of writing.