The CS ETF (IE) on MSCI EMU ETF is suitable as a core equity holding to gain exposure to stocks domiciled in the European Monetary Union (EMU). The exclusion of non-EMU companies from the benchmark index increases its sector concentration compared to broader European indices such as the STOXX Europe 600. More specifically, the MSCI EMU tends to overweight financials, telecom, and utilities and underweight healthcare compared to the STOXX Europe 600. Despite these differences in sector allocations, the two indices have maintained nearly perfect positive correlation over the past 10 years (~99%). Over the same timeframe, the MSCI EMU index has also exhibited a high historical correlation (~95%) to broad international equity indices (e.g. MSCI World GR), which reflects the multinational nature of the business lines of many of the companies making up the index.
In the fourth quarter of 2012, Eurozone GDP contracted far more severely than economists had expected. Eurozone GDP fell by 0.6% compared with the prior quarter and 0.5% for the entire calendar year. The majority of forecasters are not expecting 2013 to be much better – predicting stagnation on average, though opinions differ widely. Pessimism appears to have taken hold even in the hearts of Europe’s banner-bearers. Mario Draghi, President of the ECB, recently stated that “risks for economic activity are still on the downside because of the high unemployment, because of weak demand, low consumption, (and) low investment.” As Draghi suggests, it is hard to find a bright-spot in the Eurozone’s economy right now. Even Germany, commonly cited as Europe’s best hope for growth, floundered in the fourth quarter of 2012, with GDP contracting 0.6%.
Eurozone household income per capita fell by 0.3% in the third quarter of 2012 and 0.5% in the second quarter (in real terms). Not surprisingly, this bodes ill for an economy greased by consumption expenditure. Indeed, household real consumption per capita decreased 0.4% in the third quarter of 2012. Other data corroborate the staying power of this phenomenon – retail trade volume was down 0.8% in December 2012 compared with November and fell 1.7% for the calendar year 2012. Meanwhile, tax revenues are on the rise. In 2011, total tax revenues increased to 40.8% of GDP, according to Eurostat. Furthermore, the share of tax revenues from income or wealth rose in 2011 to 12.6% of GDP. Finally, Europe’s consumers are continuing to save. In the third quarter 2012, the gross savings rate of Eurozone households was 13% indicating a slight increase from 12.9% observed in the prior quarter. Fitting the pieces together, the Eurozone consumer, on average, is making less money, spending less, getting taxed more, and saving more. Though this is not an encouraging sign, these trends are reversible. On average, Eurozone consumers are saving 13% of income, indicating that they have room to begin to consume if sentiment turns the corner. Indeed, given the historic volatility of consumer saving habits (savings rapidly spiked mid-crisis in 2008 peaking at 16%), it seems evident that consumers are adept at deciding when and how much to save depending on the outlook for the economy.
Unlike consumer savings rates, which can be adjusted with greater speed, housing data may signal the start of a much more worrisome development. According to Eurostat, house prices in the Eurozone fell 2.5% in the third quarter 2012 compared with the year prior and 0.7% compared with the second quarter. Over the past year, the largest falls in house prices were observed in Spain (-15.2%), Ireland (-9.6%), the Netherlands (-8.7%), and Portugal (-7.7%). Empirically, housing wealth has proved to be a greater impetus to increased consumer spending than non-housing wealth (at a ratio of 3-to-1 according to US Fed economists). This wealth effect has historically tended to be a major driver of recoveries following recessions – consumer spending returns as house prices rise. Therefore, for a consumption-driven economy like Europe, GDP growth will be partially tied to level of house prices.
The MSCI EMU NR index includes approximately 85% of the free-float adjusted market capitalisation of all publicly-traded companies from European Monetary Union countries. Components must meet minimum criteria for liquidity, foreign ownership, as well as a waiting period for newly-listed stocks. Eligible securities are weighed by free-float adjusted market capitalisation. Because closely held firms will have a smaller share of their aggregate market capitalisation floated on public exchanges, the free-float adjustment serves to ensure that the underlying liquidity of the holdings is superior relative to a pure market capitalisation weighting. The index is reviewed quarterly, with May and November semi-annual reviews tending to be more comprehensive than those undertaken in February and August. As of this writing, there are 249 companies included in the index. French and German equities make up approximately 64% of the index by value. The top sector weighting is financials (~21%), followed by industrials (~13%), consumer staples (~12%), and consumer discretionary (~12%).
The CS ETF (IE) on MSCI EMU uses physical replication techniques to track the performance of the MSCI EMU index. Given the large number of index constituents, the ETF engages in an optimised sampling technique to track the reference index. Optimised sampling entails the fund investing in a representative selection rather than in all the securities making up the reference index. This selection is based on a mathematical optimisation procedure with the aim of realising the lowest divergence from the reference index. The ETF reinvests all dividends directly into the fund. This procedure is seen as minimising tracking error by eliminating any source of cash drag. The fund is domiciled in Ireland and was launched in December 2010. At this time, our understanding is that Credit Suisse does not engage in securities lending for its Irish domiciled funds. Its base currency is Euros.
At the time of writing, there are a significant number of ETFs tracking the broad Eurozone equity market. In seeking this broad equity exposure, investors should primarily consider their desired level of index concentration from both a sector and geographic perspective. Investors seeking strictly large-cap European exposure are likely to consider ETFs that track the DJ Euro STOXX 50 index as this is the most widely-tracked index in Europe. There are plenty of alternatives available from multiple providers, including iShares, Credit Suisse, HSBC, ComStage, Source, Lyxor, UBS, ETFLab and BBVA. The largest and most heavily-traded ETF tracking this index is the Lyxor ETF EURO STOXX 50 A. The fund charges a TER of 0.25%. The cheapest option (speaking strictly in terms of TER) is offered by db X-trackers with a TER of 0.00%.
Investors preferring a pan-European exposure, including companies outside the Eurozone, can look for ETFs tracking broader European large cap indices such as the MSCI Europe and the STOXX Europe 600. Again here, there is no shortage of options, with all the major providers offering funds that track the MSCI Europe at TERs ranging from 0.25% to 0.35%. Investors preferring the STOXX Europe 600 index could consider the iShares STOXX Europe 600 with a TER of 0.21%. This fund has by far the most on-exchange volume of any of the ETFs tracking the STOXX Europe 600.