European Equity Sector ETFs — On The Rise?

One area where the European ETF market has consistently lagged behind its US counterpart is in the use of equity sector ETFs.  While a boom area in the North American market, sector ETFs in Europe have tended to be overlooked by investors in favour of other financial products, notably over-the-counter (“OTC”) sector swaps. Long/short players, like hedge funds and other absolute return investors, have until this year preferred the swap route, with contracts written by investment banks.

However there are signs that this is changing.  The provision of leverage by bank prime brokerage units has become ever more expensive, removing one of the advantages of the swap route.  And with concerns about bank failures on the increase since last year, the cost of insuring against counterparty risk has also had to be factored in by investors.  Both trends have highlighted the relative safety, and transparency of pricing, of ETFs.

Most European equity sector ETFs track supersectors from the DJ Stoxx 600 index, which includes the largest 600 stocks in Europe by market capitalisation.  The nineteen sector indices select their components according to the Industry Classification Benchmark (“ICB”).  Constituents are weighted by free-float market capitalisation, with index reviews taking place quarterly.

The three leading European ETF providers – iShares, Lyxor and db x-trackers – all offer ETFs based on these indices.  Lyxor and iShares have ETFs tracking eighteen of the nineteen supersectors (both exclude real estate). iShares in fact offers two versions of each sector ETF, one using physical replication (and priced at 0.52% per annum), and one using swap-based replication (priced at 0.32% p.a.). Lyxor’s sector ETFs are all swap-based, and are priced at 0.30% per annum. Deutsche Bank has ETFs tracking ten of the nineteen DJ Stoxx supersectors (all swap-based, and also at 0.30%), and also five ETFs tracking short versions of the indices (with a total expense ratio of 0.50%).

Comstage, the Commerzbank subsidiary that launched its ETF range in September, has introduced some price competition to this area of the market, pricing all its (swap-based) DJ Stoxx 600 sector ETFs at 0.25% per annum.  Comstage also recently added a real estate sector ETF, to complete its coverage of all nineteen DJ Stoxx supersectors.

There are also European equity sector ETFs based on different indices, with EasyETF offering ten ETFs tracking the sector sub-indices of the Eurozone DJ Euro Stoxx index, and Street Tracks, the State Street subsidiary, offering nine sector equity ETFs tracking MSCI Europe indices.  For the purposes of simplicity, however, we will concentrate on the DJ Stoxx 600 indices for the remainder of this article.

A review of the supersector total return indices (i.e. calculated to include the reinvestment of dividends), conducted on the DJ Stoxx website on 24 November, reminds us how brutal 2008 has been to equity investors.

 

	YTD (%)	1Y (%)	3Y (%)	5Y (%)
DJ Stoxx 600 Automobiles and Parts	-42.73	-42.38	-6.10	24.06
DJ Stoxx 600 Banks	-64.45	-63.61	-61.62	-45.40
DJ Stoxx 600 Basic Resources	-63.92	-63.14	-30.74	17.62
DJ Stoxx 600 Chemicals	-44.78	-39.31	-8.58	42.13
DJ Stoxx 600 Construction & Materials	-53.68	-53.65	-32.74	12.10
DJ Stoxx 600 Financial Services	-55.91	-54.69	-39.61	0.26
DJ Stoxx 600 Food & Beverage	-29.28	-28.75	-5.89	31.14
DJ Stoxx 600 Health Care	-18.71	-20.28	-21.66	5.40
DJ Stoxx 600 Industrial Goods & Services	-52.32	-50.49	-29.03	-0.60
DJ Stoxx 600 Insurance	-53.23	-51.59	-46.37	-22.79
DJ Stoxx 600 Media	-41.07	-39.26	-34.69	-22.75
DJ Stoxx 600 Oil & Gas	-37.80	-34.94	-29.25	23.35
DJ Stoxx 600 Personal & Household Goods	-41.05	-38.73	-19.09	15.49
DJ Stoxx 600 Real Estate	-52.23	-52.50	-50.34	-10.58
DJ Stoxx 600 Retail	-43.56	-45.60	-22.84	-9.56
DJ Stoxx 600 Technology	-51.49	-50.71	-47.67	-39.67
DJ Stoxx 600 Telecommunications	-35.29	-36.27	-6.55	11.88
DJ Stoxx 600 Travel & Leisure	-48.27	-49.10	-41.17	-23.33
DJ Stoxx 600 Utilities	-38.83	-37.55	8.16	87.33