Investing in Russian and Eastern Europe ETFs

by: Bennington Investment Ideas

Eastern Europe might not always be readily associated with free markets and capitalism. But a quick look shows that there are opportunities to capture some benefit from these markets. This article will examine a couple of ETFs associated with former Eastern Bloc countries, Russia, and some general emerging market Europe ETFs. I've also included some countries that are now referred to as Central Europe or even Western Europe. The terms are pretty loosely used and very open to debate as to whether a given country is in a given region of Europe. I've also excluded Turkey from this review.

"Eastern" Europe and Russia ETFs
Ticker Name Assets ($ Millions) Yield
RSX Market Vectors Russia ETF 3,270 0.5%
EWG iShares MSCI Germany Fund 2,650 1.1%
CEE Central Europe and Russia Fund, Inc. (The) 599 0.6%
GUR SPDR S&P Emerging Europe ETF 235 0.9%
EWO iShares MSCI Austria Index Fund 207 1.1%
RBL SPDR S&P Russia ETF 146 NA
TRF Templeton Russia and East European Fund Inc. 137 NA
PLND Market Vectors Poland ETF 65 0.8%
ESR iShares MSCI Emerg Mkts Eastern Europe Index 32 0.6%
Source: Yahoo!Finance downloaded on March 22, 2011.

The first pass analysis is a simple look at correlation to the SPDR S&P 500 Trust ETF (NYSEARCA:
SPY) as well as a look at recent returns.

Basic Performance Statistics
Ticker 24 Month Correlation to SPY 12 Month Return 24 Month Return
SPY 100.0% 15.0% 71.8%
EWG 92.4% 13.9% 71.9%
EWO 83.5% 15.9% 95.6%
GUR 79.5% 19.1% 140.3%
CEE 75.1% 18.5% 182.8%
RSX 73.0% 13.7% 178.6%
TRF 62.6% 15.8% 166.1%
RBL NA 21.8% NA
ESR NA 22.9% NA

Source: Yahoo!Finance for historical monthly split and dividend adjusted stock prices.

The first observation is that both Germany and Austria show strong correlations to SPY. The next observation is that many of the ETFs are very new and offer limited histories. The various Russia and broader ETFs have somewhat lower correlations. These are actually lower than iShares MSCI Brazil Fund ETF (NYSEARCA:EWZ), which has around an 80% correlation. However, while there are not tremendous diversification benefits, the returns over 1 and 2 years were consistently better than the SPY. It is also readily noted that they recovered very strongly in 2009-2010, suggesting that there was a significant selloff during the 2008 financial crisis.

Country Perspectives
These ETFs create exposure to Eastern Europe markets, and I'm using that term pretty loosely.

Country Statistics
Country February 2011 Total Equity Market Capitalization ($ millions) 2010 GDP (PPP basis) ($ millions) (IMF) Ratio # of Companies Average Size ($ millions)
United States $18,532,444 14,624,184 126.7% 5,091 3,640
Germany $1,519,201 2,932,036 51.8% 755 2,012
Russia $1,052,703 2,218,764 47.4% 250 4,211
Austria $130,256 330,496 39.4% 108 1,206
Poland $196,725 717,537 27.4% 608 324
Hungary $31,963 188,403 17.0% 52 615
Slovenia $9,053 56,314 16.1% 70 129

Source: Number of companies and traded market capitalization are from World Federation of Exchanges. GDP figures are from International Monetary Fund as seen in Wikipedia. Data was downloaded on March 22, 2011.

One of the first observations is that these countries are extremely undercapitalized relative to the United States. Even Germany shows a pretty low ratio-- which I found to be surprising. I wrote an article focused on Latin American ETFs that showed much higher ratios - Brazil is around 70% and Chile is actually higher than the U.S. at ~130%. However, there are probably many country specific issues that could explain this result.

The second observation is a little more expected - that the more developed countries reviewed, which are not really Eastern Europe, showed much higher average company sizes. The next analysis is to look at sector allocations.

ETF Sector Allocations
Basic materials 2.9% 11.6% 15.1% 8.8% 26.5% 15.0% 16.6% 22.0%
Consumer cyclical 9.3% 17.4% 4.6% 3.6% 2.9% 1.6% 1.7% 0.4%
Financial services 14.9% 18.6% 26.6% 37.2% 12.8% 22.1% 14.3% 2.7%
Real estate 1.6% 0.0% 15.4% 2.9% 1.0% 0.4% 0.3% 0.5%
Consumer defensive 10.6% 2.7% 0.0% 9.4% 4.9% 2.8% 3.5% 5.0%
Healthcare 10.7% 10.2% 0.0% 0.5% 0.7% 1.2% 1.1% 1.4%
Utilities 3.1% 9.2% 5.5% 10.4% 2.7% 3.6% 5.1% 3.0%
Communication services 4.2% 4.2% 7.5% 6.9% 6.8% 8.7% 5.5% 8.7%
Energy 12.9% 0.0% 12.5% 14.3% 38.6% 40.5% 50.9% 53.6%
Industrials 12.7% 20.1% 11.1% 2.7% 3.1% 3.6% 0.9% 2.7%
Technology 17.2% 6.1% 1.6% 3.5% 0.0% 0.5% 0.2% 0.0%

Source: Yahoo!Finance. Data was unavailable for CEE and TRF.

My first observation is that unlike Latin American ETFs, these ETFs provide better sector diversification. Both EWG and EWO show very good diversification. I also ordered the tickers from left to right in order of increasing energy percentage. Both RSX and RBL are Russia-focused ETFs and have heavy exposure to energy through Gazprom (OTCPK:OGZPY) holdings. However, GUR and ESR are supposed to be broader ETFs. They also have high energy percentages, which, upon further research, showed enormous exposure to Gazprom and to other Russian companies.

This actually raises a pretty big question about what you are actually getting with some of the broader "Eastern" Europe ETFs. So I reran some correlation analysis against RSX, which I will use as the benchmark "Russia" ETF. The results are below:

Correlations to RSX
Ticker 46 month Correlation 17 month correlation
RSX 100.0% 100.0%
ESR NA 93.0%
GUR 95.8% 91.7%
CEE 92.4% 90.3%
TRF 84.9% 89.5%
SPY 74.5% 90.0%

Source: Yahoo!Finance for monthly prices

So this analysis shows extremely high correlations between ESR, GUR, CEE, and TRF and RSX, i.e., the broader Eastern Europe ETFs are very correlated to purely Russia-focused ETFs. Also, the Poland ETF PLND showed a high correlation to RSX as well - 88% over its 15 month life.

ETFs often create a good way to create geographic exposure. However, in reviewing these options for Eastern Europe, the effective diversification is really limited to two choices:
  1. Create exposure to EWO (Austria) and EWG (Germany) which tracks the U.S. reasonably well.

  2. Create exposure to Russia.

So if you are seeking exposure to Eastern Europe - either recognize that it is really exposure to Russia or you'll have to look somewhere other than these ETFs for it.

Disclosure: I am long SPY.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.

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