Western Europe ETFs: Still Important

Monday, January 26, 2009

Europe holds nearly 30% of equities by market value, but few American ETF investors hold so much in their portfolios. Their attention is caught more by higher projected growth in Asia and emerging markets and high correlations with the US market makes Europe seem less relevant. But Europe should not be overlooked, and numerous ETFs help investors make appropriate plays.

Despite dismal projections for 2009 on nearly any scale, Western Europe remains positioned to ride out economic turmoil better than the US in some regards. Its total debt-to-GDP is lower than the US, and it finished 2008 with a lower government budget deficit (-1.6% vs. -3.2% for the US). Also, Americans may be surprised to learn that GDP growth per capita is higher in Europe, even if aggregate US growth is higher due to immigration. Finally, European stocks are priced in Euros, which are being printed with less abandon than dollars and should hold up better to inflation. The case for using European ETFs to diversify away from US equities has taken a new twist.

Europe's troubles should not be downplayed. Analysts forecast negative GDP growth for nearly every Eurozone country in 2009. Spain expects a government budget deficit of 6%, and French unemployment rates will surpass 9% in 2009, putting huge strains on welfare systems. Counteracting this are belated but sizable bank bailouts and stimulus packages. The Bank of England has a $69 billion trust fund to buy up toxic bonds and commercial paper, and Germany has a stimulus package worth $67 billion, among many other programs. As with US stocks, analysts believe Europe is a bargain, but most caution that it may take a little longer to recover. A case for timing a European recovery can be made, especially if one feels that the dollar has a bit more strength left in it.

Two broad market ETFs cover Europe. In large cap area the best choice by far is Vanguard European Stock ETF (AMEX:VGK), with its impressively low annual fees of 0.12%. VGK holds over 500 stocks in major Western European markets. This includes European Union members except those in the east, and important independent countries like Switzerland and Norway. It contains a whopping 31% in UK stocks and only 13% in Germany, Europe's largest exporter. One reason for this apparent imbalance is that England is home to many giant multinationals, while Germany has less international presence and many large privately-held firms. Turnover for VGK is a modest 15% and the median company size is about $15 Billion, firmly in large cap territory.

An alternative is iShares S&P Europe 350 ETF (NYSEArca:IEV) with annual fees of 0.60% which seems excessive for a plain vanilla Eurozone index fund. It follows a similar list of countries. UK stocks dominates, with France and Germany a distant 2nd and third. Although IEV contains fewer stocks at 350, they are sampled from a broader market than VGK, so the result is an average median company size of half that of VGK, or about $7 Billion. IEV makes sense if mid- and small-cap exposure is essential.

Returns suggest, however, that the two funds will track closely over the long haul, so the nearly half point difference in annual fees will be hard to make up:

Normally we see the SPDR line with a competitive product for such an important asset class, but in this case the only one is SPDR S&P Emerging Europe ETF (GUR) covering mostly Slavic Eastern European countries. GUR holds 58% in Russia, a country which spans the entire Asian continent and probably is not best described as European in attitude. That SPDR can ignore the traditional Eurozone is a reminder of how little focus US investors put on it.

Targeting specific countries is a common way to play Europe. Reversion to the mean has been a recurring theme in recent decades because a common currency, trading zone and fiscal policy (at least for EU members) tend to rein in outliers. The obvious strategy here is to avoid countries which have moved ahead of the mean and to concentrate on laggards. There are many country ETFs to choose from:

  • iShares MSCI Austria ETF (NYSEArca:EWO), annual fees: 0.59%
  • iShares MSCI Belgium ETF (NYSEArca:EWK), annual fees: 0.54%
  • iShares MSCI EMU ETF (NYSEArca:EZU), annual fees: 0.59%
  • iShares MSCI France ETF (NYSEArca:EWQ), annual fees: 0.54%
  • iShares MSCI Germany ETF (NYSEArca:EWG), annual fees: 0.54%
  • iShares MSCI Italy ETF (NYSEArca:EWI), annual fees: 0.54%
  • iShares MSCI Netherlands ETF (NYSEArca:EWN), annual fees: 0.54%
  • iShares MSCI Spain ETF (NYSEArca:EWP), annual fees: 0.54%
  • iShares MSCI Sweden ETF (NYSEArca:EWD), annual fees: 0.54%
  • iShares MSCI Switzerland ETF (NYSEArca:EWL), annual fees: 0.54%
  • iShares MSCI United Kingdom ETF (NYSEArca:EWU), annual fees: 0.54%
  • NETS AEX ETF (NYSEArca:AEX), annual fees: 0.47% (Netherlands)
  • NETS BEL 20 ETF (NYSEArca:BRU), annual fees: 0.47% (Belgium)
  • NETS CAC40 ETF (NYSEArca:FRC), annual fees: 0.47% (France)
  • NETS DAX ETF (AMEX:DAX), annual fees: 0.47% (Germany)
  • NETS FTSE 100 ETF (AMEX:LDN), annual fees: 0.47% (UK)

Fundamental ETFs attempting to best major European indexes include:

  • Invesco PowerShares Dynamic Europe Portfolio ETF (AMEX:PEH), annual fees: 0.75%
  • Invesco PowerShares FTSE RAFI Europe ETF (NYSEArca:PEF), annual fees: 0.75%
  • Invesco PowerShares FTSE RAFI Europe Small-Mid Portfolio ETF (AMEX:PWD), fees: 0.75%

European firms are known for their stable dividends and ability to provide shelter in down cycles (though not in 2008). There are three ETFs in this category:

  • WisdomTree Europe Dividend ETF (NYSEArca:DEB), annual fees: 0.48%
  • WisdomTree Europe High-Yield Equity ETF (NYSEArca:DEW), annual fees: 0.58%
  • WisdomTree Europe SmallCap Dividend ETF (NYSEArca:DFE), annual fees: 0.58%

Co-founder of indexfunds.com, author of two books on investing, and founder of ETFzone.com, Will has been writing on indexing issues for 8 years. He holds an MBA from the University of Texas at Austin.