Is The Ireland ETF Doomed?

by on November 19, 2010 | ETFs Mentioned:

With the end of the year rapidly approaching, 2010 has been anything but kind to the euro zone. The currency bloc has experienced its worst financial crisis since the adoption of the euro, at one point teetering on the brink of a widespread crisis and perhaps even complete collapse. Across the continent heavily indebted nations including Greece, Spain, and Portugal have struggled to get their fiscal houses in order, drawing fierce protests from citizens accustomed to generous government benefits. Despite the sometimes violent backlashes, many governments have taken bitter fiscal medicine in the form of austerity measures designed to reel in spending and stave off a potentially destabilizing crisis of confidence. But just as it appeared that Europe was getting back on its feet–the euro has rallied sharply against the greenback and some economies are showing signs of life–another major challenge appeared, this time on the Emerald Isle.

Ireland, among the first developed economies to push through unpopular austerity measures, appears to be in the midst of a downward economic spiral. The Irish banking sector has been something of a problem-child for the last few years as massive amounts of loans made during the height of the construction boom have turned toxic, forcing the already cash-strapped government to stage aggressive interventions to prevent collapse. As Ireland crawls deeper and deeper into debt concerns about the government’s solvency have mounted, and the situation has escalated to the point where the European Union is discussing a possible bailout [see also Why The European Bailout Is Just Postponing The Inevitable].

So has the luck of the Irish run out? Some would argue that it did some time ago. Starting over a year ago, Ireland experienced a mortgage default crisis–not unlike the one that sent the U.S. into a severe recession–that brought the banking sector to its knees. In order to recover during the default crisis, three of the five largest Irish banks were nationalized, and many believe that a fourth buyout may be on the way. Amid the bank buy-out, Prime Minister Brian Cowen’s government underestimated the costs necessary for financial recovery, furthering Ireland’s already deep hole. With the debt mounting over the past year Ireland now believes that it will take savings of roughly $20.5 billion over the next four years to return to financial stability [see also Is The Ireland ETF (EIRL) In Trouble?].

The Irish government has unveiled its plans to return to prosperity, and investors both at home and abroad have not been impressed. The government proposed to double spending cuts, and heavily increase taxes to eliminate a deficit that adds up to 32% of the nation’s GDP; this compared to the approximate 7% debt-to-GDP average of the euro-zone as a whole. Though some are quick to compare the sputtering country to Greece, it is important to note that the Irish have enough cash on hand to finance their government operations through June of 2011, allowing them to stay afloat for a while longer. Still, the majority of the world is rightfully skeptical that the nation can keep from drowning in its sea of debt, especially after having implemented failed restructuring plans in the past.

Amid all of the fears of the Irish debt crisis, the yields on Irish 10-year bonds recently soared near the 9% mark, roughly three times that of the German 10-year bonds, which are currently sitting at 2.7%. The skyrocketing rates will only make it that much more difficult for the country to get out of debt, leading many to believe that Ireland will not be able to do it on its own. Another factor weighing on Irish debt is the relatively low trading volume of its treasuries; with so few transactions taking place, a seemingly small sell-off can create a significant impact on the price of the bonds. And with many fearful that the government will not be able to pay investors back, the bond markets are experiencing a trading frenzy as some flee for safer ground [see also The Case For The Ireland ETF (EIRL)].

Yesterday, Ireland’s central bank governor, Patrick Honohan, said that he expected the discussion with the EU and IMF to lead to some sort of external intervention. “We’re talking about a very substantial loan for sure,” Honohan said, as the proposed bailout is expected to come in the form of “tens of billions” of euros. This comment marked the first pseudo-confirmation of a bailout from any Irish official, and stock markets cheered the development and sent Irish stocks soaring. Investors seem to hold a sense of optimism for Ireland as many feel that the bailout, if there should be one, will come before a majority of the damage is done, allowing the economy to avoid collapse and recover in due time.

The consensus appears to be that Ireland will be unable to right the ship without external intervention, and it is becoming increasingly likely that the IMF or EU will be forced to step in to save the debt-straddled isle (the EU has assured investors that any kind of bailout will not affect private investors until after mid-2013).

Ireland ETF (EIRL): A Sinking Ship?

For investors seeking exposure, long or short, to Irish equities, EIRL is an interesting option. This iShares fund tracks the MSCI Ireland Investable Market 25/50 Index , which is a free-float adjusted market capitalization weighted index onstructed such that no single issuer represents more than 25% of the weight of the index and that all issues that individually represent more than 5% of the weight of the index do not in the aggregate represent more than 50% of the weight of the index. This fund’s most notable holding lies in the Bank of Ireland (7.4%), which has been under particular scrutiny as the debt crisis unfolds. From a sector standpoint, EIRL distributes the majority of its assets to the industrial materials (35%) and consumer goods (28%) sectors, though the plagued financials industry accounts for 13% of the fund. EIRL was introduced in May of this year, near the height of the European debt crisis, so it should come as no surprise that the fund has lost 7% since inception [see also Three Responses To Kauffman’s ETF Bashing].

EIRL could present itself as a pot of gold for investors, as many have strong opinions as to where they think the bleeding Irish economy is heading. For those who believe that things will have to get worse before they get better, then this fund may be a good option for investors seeking short exposure. But if Ireland somehow manages to shore up its finances and avoid a bailout, EIRL could claw back some of the losses that have mounted in recent months.

Disclosure: Photo courtesy of Anthony Patterson. No positions at time of writing.