A New Eastern Europe ETF from iShares

By Patrick Watson

Friday, October 2 was launch day for iShares MSCI Emerging Markets Eastern Europe Index Fund (ESR). The fund tracks, not surprisingly, the MSCI Emerging Markets Eastern Europe Index. Emphasis should be on “Eastern” since Russia dominates ESR just as it once dominated the Warsaw Pact.

ETF sponsors have been racing to offer products for emerging, frontier and otherwise underrepresented markets for several years now. Since the broader benchmarks are already well-covered, the pie is being sliced thinner and thinner with funds representing sub-regions and individual countries. Global X FTSE Nordic 30 ETF (GXF) and Market Vectors Vietnam (VNM) are the two most recent examples.

The new iShares fund covers four nations: Russia, Poland, the Czech Republic, and Hungary. According to the ESR Fact Sheet and fund overview, the country breakdowns for the index as of 6/30/09 were:

• Russia 74.6%
• Poland 12.9%
• Czech Republic 6.4%
• Hungary 6.1%

Obviously ESR is really a Russia-Poland fund; the other two countries comprise less than 13% of the portfolio. The same source also reveals that slightly more than half of ESR is from one sector: energy. In fact, some 25% of the fund is from one company, Russian energy giant Gazprom.

We could criticize MSCI for constructing its indexes this way, but they simply reflect the value the markets place on these countries and companies. For better or worse, Eastern Europe is mostly Russia and Russia is mostly energy and Russian energy is mostly Gazprom.

In this regard, ESR is not unlike SPDR S&P Emerging Europe (GUR), though the SPDR offering is perhaps slightly more diversified with Turkey having the second largest country weighting at 14.6%. GUR also has a cost advantage with an expense ratio of 0.59% versus 0.72% for the new ESR fund. We suspect ESR will attract enough attention to stay off our ETF Deathwatch list; iShares is still the industry heavyweight. We will watch to see if ESR can find its niche.

Disclosure: No positions

Comments

[Paul Harper:]

I would prefer Central Europe & Russia as a moniker for this,
semantics aside, I think it is a good move from iShares for
the longer term.

Don't think I'll be placing any resource in this ETF short term,
but my hope is that the holdings will rebalance over time, with
more weighting coming into the smaller countries.

The timing is interesting, as many are touting a recovery in
Poland in the near future, also with the country set to adopt the
Euro in 2012/2013, it makes sense to give some coverage now.
Similarly the Czech Rep is also looking at 2013 as a target date
for Euro adoption.

Hungary is an interesting case, as the present government has
been talking down the Euro for the last 3 years, however the major opposition, who are expected to win a landslide in next years elections, have already said that they will look to adopt at the
earliest possible moment.

Living in Slovakia (we started with € in Jan this year), there has
been a fair amount of cushioning from the volatility that has hit the zloty, kroon & forint, to the extent that we go shopping based on
whichever currency is performing poorly.

Slovenia has also benefited in a major way from Euro adoption, compared to its neighbours Croatia & Serbia, who have
economically fallen by the wayside in the last 18 months.

With the Irish now voting for the Lisbon Treaty, having vociferously voted against it last year, I reckon we will see much more focus
in the next 9 months on Euro adoption & we may well see a rash
of new applicants.

Will be interesting to see how wide this goes, we have already
seen the governor of the Danish Central Bank say that the country would have faired much better through the financial crisis if they
had adopted, but public support as in the UK is very thin.

Oct 04 04:16 AM

[Alan Young:]

Thank you for the report.
This is a useless (to the point of idiocy) product: it's not going to be diversified enough to distinguish itself from RSX, so what's the point? An Eastern Europe ex-Russia fund would make more sense, for the few who are interested in that particular niche. iShares should be ashamed of itself. I don't share your expectation that this will attract investors.

Oct 04 04:53 AM

[Geoffrey Lordi:]

Thanks for the notice, Patrick.

Appreciate the commentary, Paul.

I think I'm forced to agree with you, Alan.

GUR and ESR are so similar as to make them non-differentiable. RSX is the pure play there, and dominant. Sure, there are slight differences in composition, cost, and focus. But not enough to make a difference in terms of performance correlations. Even a popular CEF, Morgan Stanley's "RNE", is barely dissimilar enough to make a difference (<1% in Kazakhstan is meaningless).

For those who are interested, the only fund I found after a quick review that gets folks less than 60% in Russia is the Central Europe & Russia fund (CEE). Rus still represents ~59%, but at least there's ~13% in Poland, and roughly 10% each in the Czech Republic and Turkey. (Total fees are as follows: RNE=2.16% (ouch!); CEE= 1.1%.)

At one point, I think WisdomTree's product registration included several EE currencies. Those might have been a way in that wasn't equity-based but those submissions have yet to materialize. CurrencyShares offers a Russian currency tracker, XRU, as many know.

Oct 04 03:28 PM

[Peter Medved:]

Have to agree with Paul Harper, Eastern Europe is a misnomer, the Iron Curtain was drawn aside 13 years ago.
From an investment point of view. The over weighting on Russia & energy will keep me away from this ETF. I am however invested in a UK Unit Trust from my time working & living there :

www.trustnet.com/Facts...

Similar to ESR, it has a heavy weighting in Russia & a better spread of nations than ERS, but less dependance on energy. Top holdings are in finance & telco (which is where my interest lie) Performance has been good this year(70%+), although for 3 years it was a dog. But you have to park your money somewhere.

I would be more inclined to invest in an ETF that has a larger geographic spread & a more even weighting across sectors.

Oct 05 04:39 AM