Is the Austria ETF in Trouble?

One of the major stories in recent weeks has been the resurgence of the U.S. dollar against many of its major rivals, as the greenback has reclaimed much of the ground lost in recent months against the yen, pound, and Australian dollar. But the dollar’s biggest surge has come against the euro, which has been battered by troubling events in two euro zone countries.

Several major ratings agencies have downgraded sovereign Greek debt, noting that a rapidly-eroding fiscal situation in the country threatens to set off a financial crisis. “The downgrade reflects concerns over the medium-term outlook for public finances given the weak credibility of fiscal institutions and the policy framework in Greece,” said Fitch, one of the agencies to downgrade Greece. “The lack of substantive structural policy measures reduces confidence that medium term consolidation efforts will be aggressive enough to ensure public debt ratios are stabilized and then reduced over the next three to five years.”

While the downgrade in Greece is certainly a negative development, it isn’t necessarily disastrous news. The country’s debt remains far above “junk” status, and the size of the country’s debt makes a bailout by remaining EU countries a relatively simple task. More worrisome may be the situation that is playing out on the other side of the euro zone.

Austria recently announced the nationalization of Hypo Alpe-Adria Bank International, the country’s sixth-largest bank and the second major financial institution to be nationalized since the start of the financial crisis. BayernLB, Germany’s second-biggest state-owned lender, agreed to sell its 67% for 1 euro and to inject 825 million euros into the bank. Austria is expected to inject as much as 450 million euros into the bank.

There are reports that other Austrian banks are on a “watch list,” indicating that the country’s financial industry may be on the verge of a disaster. Such a development could be devastating for the entire Austrian economy. As Austria has evolved from a primarily state-owned economy to a well-developed social market economy, the financial sector has played a major role. Vienna is one of the major financial centers of Europe, serving as a bridge to Eastern Europe and home to many of the leading corporations in business with new EU member states.

Austria ETF

Austria is one of Europe’s largest economies, meaning that Austrian equities account for a material portion of most diversified European ETFs. The iShares MSCI Austria Index Fund (EWO) offers U.S. investors a pure play on the economy, investing in 35 of the largest publicly-traded Austrian companies. EWO has been the best performing ETF in the Europe Equities ETFdb Category in 2009, gaining more than 50% on the year. But the fund has hit a rough patch as of late, losing more than 10% over the last month as worries about the sustainability of the economic recovery began to bubble up.

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The fund is tilted heavily towards banks, with the financial sector accounting for about 38% of total assets. Beyond financials, large weightings are also given to industrials (16%) and energy (13%).

Other Europe ETFs At Risk

Austria and Greece are two of the biggest lenders to Eastern European countries, making emerging European economies vulnerable to the potential crises developing elsewhere in the region. Greece, which is now relying on emerging funding from the European Central Bank, holds a market share of 29% in the banking sector of Bulgaria, and 16% in Romania and Serbia. And Austria has 16% of its banking assets exposed to Eastern Europe, the highest level in the euro zone according to Katie Martin.

There are two ETFs offering investors exposure to the emerging markets of Eastern Europe (see a head-to-head comparison of these ETFs here).

• MSCI Emerging Markets Eastern Europe Index Fund (ESR): This ETF has about 75% of its holdings in Russian equities, with the remaining quarter allocated between Poland, Czech Republic, and Hungary. Since its inception in October, ESR has returned about 9%.

• SPDR S&P Emerging Europe ETF (GUR): This ETF has a slightly smaller allocation to Russia (about 65% of the fund) and also includes Turkey in its country weightings. GUR is up more than 70% year-to-date, and offers a more attractive expense ratio (0.59% compared to 0.72% for ESR).

Disclosure: No positions at time of writing.