ETFs To Consider As Europe Tries To Solve Its Debt Crisis

by: Ramon Vredeling

As an investor it’s always wise to analyze your investment thesis from both sides of the equation. After all, every time you execute a buy trade your counterparty is actually doing the exact opposite. So, some part of you must be wondering “Am I missing something, some piece of vital information?”.

Many US investors are reading and watching the news on the European debt crisis on a daily basis and wondering to themselves what’s exactly happening on the other side of the pond. It’s relatively straightforward to recognize that many European companies and equities have been hit much harder than their US counterparts. In that sense, it’s currently more likely you will find undervalued assets in the eurozone markets. As we also know a financial crisis is usually the perfect time to accumulate positions in equities in order to build a solid foundation for future returns.

If you want to profit from relatively lower current valuation levels of European equities, but don’t feel properly equipped to select individual European-based companies, there are plenty of European-focused ETFs to choose from. But unless you have an understanding of how this crisis actually began it’s very difficult to understand where exactly to invest. Therefore, in most cases, it’s easiest to stick with ETFs which cover an entire region. It may limit your return to some extent, but the same is true for the relative risk rate you take on.

There are a number of good quality eurozone-wide ETFs, but many US investors find it difficult to locate them all to subsequently make a proper selection. Therefore, I selected the Top 12: BLDRS Europe 100 ADR Index ETF (NASDAQ:ADRU), Dow Jones EURO STOXX 50 ETF (NYSEARCA:FEZ), Dow Jones STOXX 50 ETF (NYSEARCA:FEU), Europe 2001 HOLDRS ETF (NASDAQ:EKH), First Trust DJ STOXX Select Dividend 30 Index Fund (NYSEARCA:FDD), iShares FTSE EPRA/NAREIT Europe Index Fund (NASDAQ:IFEU), iShares MSCI EMU Index Fund (BATS:EZU), iShares S&P Europe 350Index Fund (NYSEARCA:IEV), ProShares Ultra MSCI EuropeETF (NYSEARCA:UPV), Vanguard European ETF (NYSEARCA:VGK), WisdomTree Europe High-Yielding Equity Fund (NYSEARCA:DEW), WisdomTree Europe Small Cap Dividend Fund (NYSEARCA:DFE).

If the range of these 12 ETFs is a bit to broad for your taste, you can of course also invest in ETFs of specific European countries, but before doing this it’s important to know some of the reasons why the eurozone is currently in so much turmoil, and why politicians are so eager to hold onto to this concept and the single currency for as long as possible.

Initially, the introduction of the eurozone and euro resulted in increased economic growth for the countries included in this monetary union. One of the reasons was that with the common euro currency, the PIIGS - Portugal, Italy (NYSEARCA:EWI), Ireland (NYSEARCA:EIRL), Greece and Spain (NYSEARCA:EWP) - were better able to develop themselves, thereby creating greater demand for products and services. Export-driven EU-countries like Germany (NYSEARCA:EWG), France (NYSEARCA:EWQ), United Kingdom (NYSEARCA:EWU), Norway (NYSEARCA:NORW), Sweden (NYSEARCA:EWD), Belgium (NYSEARCA:EWK) and the Netherlands (NYSEARCA:EWN) were able to export like crazy!

So where did the money come from that made the PIIGS able to buy those exports? From European, Asian and US financial institutions of course, especially Northern European banks eager to expand their business across the border. Because, they now had the euro instead of pesetas, lires or drachmas, the PIIGS could borrow money cheaply. After all, Germany had implicitly guaranteed the debt. The banks earned handsomely during that period from lending and for many countries it was also beneficial in terms of additional jobs and taxes earned. It was hailed as the definitive proof that the euro was good for the participating countries and the global financial system alike.

The one problem with all this liquidity was that the PIIGS countries made increasingly bad investments. For example, Ireland, Spain and Portugal spent much of this inflow of money on the construction of shopping centers, villas, office buildings and houses. Then there were some countries that decided to spend excessive amounts of money on extra salary and bonuses for civil servants, better pensions and so forth. Ultimately, demand for property was much less than supply, so the real estate market collapsed. The PIIGS governments therefore earned less in taxes while government spending kept going up. These are some of the reasons why things eventually went south.

So, although the euro brought economic growth, part of this growth was based on producing real estate, financed by loans from banks, with insufficient underlying demand. So what actually happened is that Northern European countries subsidized their own exports and that the economic growth they enjoyed was 1) based on borrowed money, and 2) able to occur due to bad investments made by the PIIGS. These factors, along with insufficient eurozone financial regulations, a lack of oversight and proper framework to control and penalize the spending habits and resulting deficits of member states has ultimately led to the current predicament.

The consequences are clear to see. Governments and financial institutions will have to write off all this debt which the PIIGS are ultimately unable to repay in order to prevent a total collapse of the monetary union. This has become far more difficult given the billions already spent on stabilizing the global financial system after the collapse of the US subprime mortgage market in 2008. The European monetary union is part of a larger idea which has slowly evolved after World War II. European unification in itself has some clear advantages, not just economic. But in the end, you cannot have a situation where individual countries basically determine their own rules and only start to rally behind a vision or common approach when it’s the only available option left.

One good thing that has resulted from the 2008 U.S. subprime mortgage, CDO and credit crisis and now the 2011 Southern European debt crisis is a better understanding that our global financial system is interlinked to such an extent that we are no longer immune to each other’s problems. This requires a different level of regulation, cooperation and fiscal responsibility. The question is if this realization has come in time and if 1) the European Union and the euro will continue in its present form or 2) if some member states will be lost. If you believe option one in the end is more realistic, perhaps now is an opportune time for investors to make a list of potential investment opportunities in ETFs with exposure to the European market or individual member states.

Whatever the final outcome, you have to conclude that, partly due to their own financial predicaments, some of the larger European countries like the United Kingdom and France have had to come to terms with the fact that Germany is now dominating the decision-making in the debt crisis which began in Greece two years ago. Germany is predominantly setting the agenda in Brussels, and dictating the guidelines of crisis management. Germany, the Netherlands and the Scandinavian countries insist there can be no further bailout without drastic austerity measures, that private creditors must share the burden of a debt write-down and that the role of the European Central Bank (ECB) as the lender of last resort must remain limited.

For that reason I prefer European country ETFs like iShares MSCI Germany Index Fund (EWG), iShares MSCI Netherlands Index Fund (EWN), iShares MSCI Sweden Index Fund (EWD), Global X FTSE Norway 30 ETF (NORW) and Market Vectors Poland ETF (NYSEARCA:PLND) over ETFs directly related to one of the PIIGS countries, like iShares MSCI Italy Index Fund (EWI) or iShares MSCI Spain Index Fund (EWP). Even if the debt crisis is ultimately resolved without losing one or several of the member states, the Southern European countries will have a long and difficult road ahead to get their house back in order.

The Northern European countries in general have been much more fiscally responsible over the years and are still on significantly better financial footing, even compared to countries like the US. This will mean a faster and stronger recovery for those countries once the storm finally blows over, which will be reflected through their respective equity markets and associated ETFs. In investing it’s the bottom line that counts. If you are willing to look beyond today’s headline at things like underlying valuation, dividends, and potential returns, you may be surprised at what you might find.

The following is a list of other European country-focused ETFs:

iShares MSCI Austria Index Fund (NYSEARCA:EWO)

iShares MSCI Belgium Index Fund (EWK)

iShares MSCI France Index Fund (EWQ)

iShares MSCI Germany Index Fund (EWG)

iShares MSCI Italy Index Fund (EWI)

iShares MSCI Netherlands Index Fund (EWN)

iShares MSCI Spain Index Fund (EWP)

iShares MSCI Sweden Index Fund (EWD)

iShares MSCI Switzerland Index Fund (NYSEARCA:EWL)

iShares MSCI United Kingdom Index Fund (EWU)

Market Vectors Poland ETF (PLND)

MSCI Emerging Markets Eastern Europe Index Fund (NYSEARCA:ESR)

MSCI Ireland Capped Investable Market Index Fund (EIRL)

MSCI Poland Investable Market Index Fund (NYSEARCA:EPOL)

MSCI Russia Capped Index Fund (NYSEARCA:ERUS)



Market Vectors Russia ETF (NYSEARCA:RSX)

Global X FTSE Norway 30 ETF (NORW)

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.