Magazine Issues » July-August 2014


SpainLoose monetary policy has helped ETFs that target the eurozone. Nick Fitzpatrick looks at deeper reasons for Spain's gains, and asks if Southern Europe has any more rewards to give.

The Bank for International Settlements (BIS) recently warned that “euphoric” capital markets were detached from economic reality, thanks partly to ultra-low monetary policy that has led to asset booms. ETF investors who used their funds to access the eurozone could perhaps testify to that.

They have enjoyed strong performance from equity indices anchored to some of the worst-hit countries of the financial crisis, with gains of over 30%. 

In a World Cup-themed report, S&P Dow Jones Indices (SPDJI) notes that Spain and Greece equity indices had, in dollar terms, outperformed those of all the other countries in the tournament with a 46% and 41% return, respectively, in the 12 months to May 31, 2014.

The euro-based performance in the same period was also good: Spain 39% and Greece 34%. Italy and Portugal returned 31% and 25%, respectively.

But if market performance is split off from broader economic indicators, then BIS’s concerns are given clarity. Southern Europe and the Eurozone are still beset with problems. Unemployment in Spain is 25%, compared to 11.6% in the eurozone. Spain’s GDP growth was just 0.4% in the first quarter of 2014. For the Eurozone it was 0.2%.

It being widely held that central bank policy is having the most impact on investment decisions, in its June annual report BIS, which based in Switzerland, said global markets are “under the spell” of central bankers and their policies. 

If this is the case, Mario Draghi, president of the European Central Bank, is the person ETF investors have to thank the most for the Eurozone returns. Since pledging on July 26, 2012, to “do whatever it takes” to protect the Eurozone from collapse, flows into ETFs targeting the region have been increasing gradually, including from overseas investors who would not have touched European equities a few years ago.

“Capital is coming back into Europe …  you can definitely see people in the US putting money into Europe ETFs,” says Tim Edwards, SPDJI director of index investment strategy.

By way of indication, the iShares Europe ETF listed in New York saw inflows of $2.2 billion between Draghi’s 2012 announcement and May 31, 2014, figures from BlackRock show. The return was 50.98% in dollar terms, according to Yahoo Finance data. 

ETFs tableAs another indicator, the total net assets of the US-listed Vanguard European Stock Index Fund went from $6.59 billion to $23.83 billion, though this also includes market performance. The return was 44.29%.

“Two years ago from a US investor’s perspective, Europe was a difficult place to invest. It was hard to make the case for Europe to clients,” says Edwards.

This has changed – certainly in the case of Spain, though Portugal may still take longer to recover and Italy may lack the reforms needed to truly attract investors.

Shaun Port, chief investment officer at Nutmeg, a UK wealth manager that uses ETFs exclusively, says: “The recovery in Spain was an inflexion point for austerity Europe.  In our opinion, the sharp fall in Spanish labour costs set the groundwork for a sustained recovery and Spanish growth was the key driver in the revival of austerity-hit euro stocks across a range of countries.”  

European help for Spain’s beleaguered banks and a series of structural reforms have stoked a recovery that arguably puts the country ahead of others in the southern Eurozone.

José Luis Jiménez, chief executive of March Gestión de Fondos, an active manager based in Madrid, says: “Before the crash we were in deficit, but now the economy is in surplus – that is a big turn around.” 

As an active manager, he eschews ETFs. The March Gestión Valores fund, domiciled in Spain, has beaten the IBEX 35 by 24.95% over three years.

Jiménez adds: “Spain is better off compared to the rest of the periphery because it has carried out reforms, which is not the case in Italy, for example.”

With banking provision now equating to around 40% of GDP, “we probably have the best balance sheet in Europe”, Jiménez says, and Spanish banks are in “much better shape now than banks in France,

Greece and other parts of Europe, even the UK”. There have also been structural reforms to make Spanish business more efficient. For example, it is now less expensive for employers to lay-off staff.

Previously, an employer had to pay for 45 days of work for each year worked at the company. That has reduced to 33 days. 

Reforms have been met with widespread protests, like elsewhere in the Eurozone, but strong familial ties have helped ease the burden of unemployment, Jiménez says.

“Looking at the unemployment figures from outside of Spain people think ‘My God!’ However, the reality is somewhat different. Unlike in the UK the family network is very strong and so it provides a cushion for those seeking work.”

Positive economic indicators after summer 2013 suggested a positive outlook for job creation even with a low growth rate, according to Jiménez. Migrants have left the country and the local workforce is not demanding higher salaries.

Meanwhile, companies are increasing their exports. “Corporates were much more domestically focused before but they are now exporting more and more.” As they hunt foreign sales, any increased profitability will help the economy, says Jiménez.

However, Port warns that Spanish companies are more exposed to a downturn in the emerging markets.

2014 is not the first year that passive investors will have benefited from a recovering Spain. The IBEX 35, the main share index, returned 22.23% last year.

Investing in the Lyxor Ucits ETF IBEX 35 would have returned 29.7% in euro terms in the 12 months to May 30, 2014, according to Yahoo Finance data. The IBEX 35 itself returned about 30% over the same period.

The Amundi ETF MSCI Spain, which is listed in Milan and other markets, returned 36.07%, while the MSCI Spain itself returned about 37%.

Investors who feel they might have missed out on Spain may want to look at Italy. That’s what Port at Nutmeg is doing.

He says Nutmeg prefers Italy over Spain now for reasons including a greater scope for reforms since Italy’s Democratic Party won 41% of the vote in the European elections. Also, Italy simply has a lot of catching up to do, with stocks recently 36% below the 2007/08 peak.

Central bankers may be on hand to provide more euphoria in the weeks ahead, but policy is widely viewed to be diverging with mixed views between bankers about inflation. 

Hopefully Italy will follow through with those reforms soon, which Port says are not yet priced into shares.

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