The fund provides access to many of the largest and most liquid bank stocks in the Eurozone. Because of the narrow focus, it should be used as a tactical tool to express a view on European banks. Not only is the sector focus of the underlying index narrow in scope, but at the security level it is very highly concentrated in the top names. And what the last few years has shown us is that the fortunes of large, highly leveraged financial institutions can change quickly in the face of shifting market sentiment. With this type of investment, caution is therefore required.
Since the start of 1999, the EURO STOXX Banks Index has been highly erratic, exhibiting annualised volatility of 27.8%, versus 16.2% for the wider MSCI Europe Index. During the same period it has shown correlation to the MSCI Europe Index of 86% and to the MSCI World of 82%.
The Financials sector is already a significant weight within the broader European market, for example it makes up more than 21% of the EURO STOXX Index. So combining this fund with a European equity product may result in overweighting this particular sector.
The fund pays out dividends from the underlying stocks up to four times per year, currently at an annual yield level of 2.63%. So it may suit an investor seeking moderate levels of income, although the tax implications of such distributions for each investor would have to be taken into consideration.
In the aftermath of the global financial crisis, sovereign debt has become a staggering concern for Europe, and of particular concern for European banks that are large holders of it. Government-debt-to-GDP levels have gone above 100% in several eurozone countries, Ireland and Portugal have had to be bailed out by the European Union and the International Monetary Fund (IMF), and Greece has seen a full-blown restructuring of its debt, with haircuts of more than 50%. The lifelines being tossed to various countries are also a way to shore up the banks that have lent to them.
The good news is that banks have generally recapitalised. In June 2011, the European Banking Authority (EBA) suggested that 27 banks had a combined capital shortfall of €76 billion to get them to Core Tier 1 ratios of 9%. In the industry group’s final report on the recapitalisation project, released in October 2012, it revealed that those banks have gone above and beyond the target, bolstering their balance sheets by a collective total of €116 billion. Indeed, Morningstar research has found that Core Tier 1 ratios of European banks have improved and compare favourably to their U.S. peers.
But the banks’ ratios of common tangible equity to tangible assets, a more robust measure of balance sheet risk, have failed to show similar improvement, and in some cases have actually deteriorated since the end of 2010. On average the European banks are well below U.S. banks by this metric.
With some way yet to go in shoring up capital cushions, the European banks—historically bid dividend payers—will likely offer low or no dividend payouts for the next few years, which could weigh heavily on their valuations.
As could be expected, having been beset by crisis for much of the last five years, the performance of the EURO STOXX Banks Index has been miserable. An amount invested in the Index at the start of 1999 would have cumulatively lost 42.0% of its value through September 2012, despite a healthy rally off the lows of the financial crisis. That compares with cumulative gains of 39.1% for the broader MSCI Europe Index and 35.3% for the MSCI World over the same period. Between June 2007 and May 2012, the index suffered a peak-to-trough drawdown of more than 81%.
After bottoming out at 3.5 in January 2009, the price-to-earnings ratio for the index has rebounded to 14.3 at the end of December 2012. Since September 2007 it has averaged 8.6.
The index is very top-heavy, dominated by the fortunes of Banco Santander and a handful of other top positions. Using the most recent closing price as of the time of this writing, shares of Banco Santander are trading at a 6.7% discount to what Morningstar’s equity research team reckons the company’s fair value is. Next largest position BNP Paribas is also trading at a 6.7% discount to Morningstar’s fair value estimate, and after that Banco Bilbao Vizcaya Argentaria is trading at an 11.6% premium and Deutsche Bank is trading at a 12.7% discount.
The EURO STOXX Banks Index is a free-float market capitalisation-weighted index covering bank stocks from the following countries: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain.
At the end of December 2012 it consisted of 28 stocks, but fully half of those had weights of less than 1%. Banco Santander, the top weight, accounted for 21.2% of the total, and the top 10 names made up 86.2%. The median market cap was €2.9 billion.
The universe is screened to include only stocks that pass a minimum level of trading volume, and then ranked by size. The index is reviewed quarterly, with buffers around the entrance criteria in order to reduce the turnover.
During the quarterly rebalancing, the size of the top position is capped at 30% and the second-largest at 15%. Intra-quarter, immediate action is taken to cap the top name at 35% and the second-largest at 20%.
The fund uses full physical replication to try to capture the performance of the EURO STOXX Banks Net Total Return Index, owning – to the extent possible and efficient – shares in all of the underlying constituents in the same weights as those of the index. In certain circumstances it may also use derivatives to achieve its objectives. The fund is domiciled in Germany and uses the euro as its base currency. At the time of writing it had assets of €489 million.
Cash received as dividends from the underlying stocks is held by the fund until distributions are made to fund unitholders as many as four times a year. This can create a cash drag on the portfolio, causing it to underperform its benchmark in rising markets, and outperform in declining markets.
The fund has a total expense ratio (TER) of 0.51%, which is pricier than some other products offering similar exposure.
Other costs potentially borne by the unitholder but not included in the total expense ratio include transaction costs on the infrequent occasions when the underlying holdings change, bid-ask spreads on the ETF, and brokerage fees when buy and sell orders are placed for ETF shares.
To get exposure to European financial stocks, there are a few choices. These include Amundi ETF MSCI Europe Banks, ComStage ETF STOXX Europe 600 Banks, SPDR MSCI Europe Financials, db x-trackers STOXX Europe 600 Banks, Source STOXX Europe 600 Opt Banks, which excludes the least liquid components of the broader index, EasyETF STOXX Europe 600 Banks, and Lyxor ETF STOXX Europe 600 Banks. Of these, the Lyxor fund is the largest, followed closely by iShares EURO STOXX Banks. The Amundi and ComStage products have the lowest TER, at 0.25% each.