Given the broad weakness in the euro zone throughout 2011 and the ever-present fears of default in a number of nations, most investors shouldn’t be surprised to read that all of the ETFs in the European Equities ETFdb Category are down in year-to-date terms. In fact, at time of writing, only the iShares MSCI UK Index Fund (EWU) was down less than 10% on the year while most funds were off by more than twenty percent. Thanks to the heavy focus on the PIIGS economies, one would expect to see national ETFs such as those tracking Spain and Italy, would be vying for the title of worst performer so far this year, but this has not been the case. While the Italian ETF, EWI, is close to the worst performer, it still has proven to be no match for one of the country’s neighbors to the north and their ETF; Austria and the iShares MSCI Austria Index Fund (EWO).
EWO is, at time of writing, down 29.5% so far in 2011, beating out all other funds in the European category by at least 200 basis points on the downside, if not more when compared to the better performing funds in the space. This should be somewhat surprising to many since the country isn’t a member of the PIIGS group and has inflation and debt relatively under control. Furthermore, the country has a relatively solid trade position, doing business with a number of nations while running only a minor trade deficit. Additionally, thanks to the country’s ease of doing business and historic ties to the emerging eastern European region, it has become a favorite spot for those looking to access developing nations while still basing operations in a robust developed market.
With that being said, all of the positives of the Austrian economy have been largely overshadowed by the country’s financial sector in recent months as this important corner of the nation has dragged down both growth hopes and market expectations throughout the year. Worries have largely come about from the nation’s banking sector and its exposure to the PIIGS nations. Accoridng to a report from CNBC, close to 2.6% of the banking sector assets go to PIIGS nations with close to $3.4 billion going to Greece and $22.2 billion to Italy.
In total, the country has about $36.8 billion in exposure to the five nation group and while this may not sound like a lot in the grand scheme of the euro zone’s troubles, consider that Austria’s financial sector isn’t nearly as large in terms of total banking assets as many other financial centers in Europe, making a rough stretch for the financial sector much harder to absorb for Austria than the giants of the euro zone [see all the European ETFs here].
Second, and more recently, is another event stemming from beyond Austria’s borders, this time involving the country’s neighbors both to its west and east, Switzerland and Hungary. Switzerland’s decision to peg their currency to the euro has apparently had far reaching effects on the economies of central Europe and especially so on the country of Hungary. Apparently, thanks to lower interest rates in Switzerland when compared to Hungary, many Hungarians decided to take out loans from banks– generally Austrian ones– in francs instead of forints. While this may have seemed like a good idea at the time given the savings in interest, a rapid appreciation of the Swiss franc to near-historic levels has had a devastating impact on many Hungarian borrowers, forcing the government of the country to go to drastic measures.
In a recent move, the Hungarian government declared that borrowers who make their payments on time can shift their loans back into the home currency at a rate of 180 forints to a franc and 250 forint to a euro. Given that current exchange rates are at 236 HUF per franc and 287 HUF per euro, this represents a rather large overvaluation of the Hungarian currency in true market terms. Since the Hungarian government expects about 10% of the mortgages to be refinanced under this scheme– with some estimates going far higher due to two-thirds of citizens in Hungary using foreign currency loans–this could represent a loss of about 2 billion euros for the banks, should the high end of expectations be met. Since Austrian banks are among the biggest underwriters of these loans they stand to lose the most from the plan, especially if Hungarian officials do not fall to growing pressure to scale back the system.
Thanks to all this, the Austrian ETF has been pretty much decimated so far in 2011. The fund which tracks the MSCI Austria Inversatble Market Index, measures the broad performance of the Austrian equity market, allocating to 33 securities in total. In terms of sector exposure, materials and energy both make up over 10%, industrials constitute just over 20%, and a plurality of assets goes towards the troubled financial sector at 37.5% of total assets. Given how much of the fund is exposed to financials it shouldn’t surprise investors to see EWO in trouble so far this year. In fact, the fund’s top holding, Erste Group Bank AG, which makes up just under 14% of total assets, currently sees its shares near their 52 week low and are off by more than 43% so far in 2011, underscoring just how bad things have been in the Austrian financial sector this year [see charts of EWO here].
The only thing that Austrian investors can take solace in is that over the longer term, the product has done much better. While it is still down significantly, over both the past three and five year periods it drops out of the running for worst performing ETF in the time periods suggesting that if recent events can be contained the fund can go back to performing in line with its strong fundamentals. In fact, EWO has a dividend of about half a percent and a PE ratio below 11 suggesting it may not have much further to fall, assuming of course the worst doesn’t happen in several PIIGS markets. Either way, whether the fund can turn it around later this year remains to be seen but if recent history is a guide, events beyond Austria’s control are likely to play an outsized impact in the overall return of the fund for the foreseeable future.
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