The EU may aspire to economic integration, but the performance of the various European single country funds reveals the true extent of the divisions, as Nick Sudbury reports
It has become apparent that it is not just the UK that has a north-south divide. The divergent state of the EU economies has created a crisis of confidence in the euro, while showing that the region is effectively split in two.
To the south are the heavily indebted countries like Greece, Spain and Italy that have done so much to undermine the euro. Most of the strength is to the north, with Germany and France forming the heart of the union. These are backed by well-funded economies that have remained outside of the single currency, such as Switzerland, Sweden and Norway.
This economic dichotomy has had a marked effect on the performance of the respective stock markets, but by using the European single country ETFs, it is possible to take advantage of the main underlying trends.
Leading the way
The top performers in the sector during the last year have all been Scandinavian products tracking Norwegian or Swedish equities. Leading the way was XACT Bull with a gain of 57.22%. This leveraged ETF aims to pay out 150% of the daily change in the Swedish OMX index by investing in a mixture of cash and futures.
Henrik Norén, managing director of XACT, says the number of trades is much higher in their leveraged funds than in their non-leveraged funds, but the average size of each trade is much lower. “This indicates that there are many more retail investors investing in our leveraged funds and they tend to be more speculative than the typical institutional investor, who normally has a more long-term view.”
XACT is owned by Handelsbanken, one of the biggest Nordic banks. The firm’s largest ETF is XACT OMXS30, which tracks a benchmark of the 30 most traded stocks on the Stockholm exchange. The fund was up 44.31% in the last 12 months.
“The general interest in this fund has gone up significantly during the last year, both in terms of turnover and AUM. This is probably partly due to a higher interest from foreign institutional investors,” explains Norén.
Most of the gains from the Scandinavian ETFs have been driven by strong local market returns, but the currency exposure has also played a significant role. Norwegian and Swedish public finances are in relatively good health and this has helped their exchange rates to appreciate against the pound. In the last year a sterling-based investor would have made around 12% from the increase in the Swedish krona and almost 9% from the Norwegian krone.
It is a similar scenario for investors in the various Swiss equity ETFs. These have had an excellent year with returns ranging from the 33.30% achieved by the Credit Suisse small/mid cap ETF on SMIM index, to the 23.29% performance of the large cap exposure provided by the SMI ETF from db x-trackers.
Sterling-based investors owe around 9% of this to a favourable exchange rate movement, with the Swiss franc benefiting from its reputation as one of the strongest currencies in the world.
The majority of these ETFs track the Swiss Market Index (SMI), which measures the performance of the country’s largest and most liquid stocks. One such fund is the db x-trackers SMI ETF. This is available on the Swiss exchange in the local currency and there are also euro-based versions traded in Germany and Italy. The total expense ratio (TER) is 0.30%.
The db x-trackers SMI ETF is yielding 2.97% with a PE ratio of 15.19, but investors need to be mindful of the large weightings in stocks like Nestle, Novartis and Roche Holding which currently make up 56% of the portfolio.
Those who are concerned about this might prefer the db x-trackers SLI ETF, which has a capping mechanism. This has produced almost 3% of additional return in the last year albeit at a higher level of volatility and is marginally more expensive with a TER of 0.35%.
Manooj Mistry, head of db x-trackers UK, says the SMI is the main Swiss equity benchmark and is made up of 20 of the largest stocks with no caps applied to the weightings. “In comparison, the SLI comprises the 30 most liquid Swiss stocks and has a mechanism to cap the maximum weight of the four largest constituents at 9% each.”
The SMI is the more established and familiar benchmark of the two. This is mirrored in the funds, with the db x-trackers SMI ETF having CHF362m (£227m) in assets under management, whereas the db x-trackers SLI ETF has just CHF43m.
“Some clients are looking for benchmark market performance, which means they do not want to have the weightings of constituents capped and would use the SMI ETF. Others want broader market exposure, in which case the SLI may be the more attractive as it includes higher weightings in the industrials and basic materials,” says Mistry.
The other main area of strong performance has been the German single country ETFs. There are more than 20 of these on the market with most tracking the large caps of the DAX. The returns in the last year have typically been just under 20% for UK-based investors, including a small exchange loss by virtue of the weakness of the euro.
The best performer was iShares MDAX (DE), which replicates the performance of 50 mid-caps that trade on the Prime Standard segment of the Frankfurt Stock Exchange. In the last 12 months this ETF returned almost 35%.
“The MDAX is a very different benchmark compared to the DAX given the bias to mid-cap companies and the minimal exposure to banks and insurance companies,” explains Nizam Hamid, head of sales strategy for iShares in Europe. “Ideally one should look at the MDAX as a different exposure that gives investors access to mid-cap engineering related export companies that have benefitted from the weakness of the euro.”
On a five year view, the returns from the DAX and MDAX are almost identical, with only a 1% difference between them, but the latter is the more cyclically exposed and goes through periods of over and under performance.
“Investors need to understand that with the DAX and the MDAX the choice is not so much large cap versus mid-cap, but a clear distinction in the industry and sector coverage and the variety of factors that impact these returns,” says Hamid. “One can expect that the DAX should provide more stable returns with less economic variance than the MDAX so at times of greater uncertainty the DAX should be the stronger of the two.”
The PIGS of Europe
It will come as no surprise that other than a bear fund linked to the Norwegian market, all the worst performers track the Southern European countries with the highest levels of public sector debt. Spanish and Italian equity ETFs have lost between 15% and 20% in the last six months, while the equivalent Greek products have fallen 20% to 30%.
Christopher Aldous, chief executive of Evercore Pan-Asset, says they are extremely underweight in European equities. “In fact we have no euro exposure at all as we took a very negative view of the euro’s prospects following the European Central Bank’s decision to support peripheral eurozone country debt.”
He adds the bank stress-tests have provided a little relief for the euro, but were clearly designed to say what the market wanted to hear. Aldous says: “Like many others we have not changed our negative outlook for the euro. We also have a negative five year strategic view of the region which is based on the weakness of the bank sector and its inability to lend to promote economic growth, coupled with enforced austerity measures in most countries.”
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