One of the best-performing ETFs for 2006 is the iShares MSCI Spain Index Fund (NYSE:EWP). The fund has been running like a bull in Pamplona this year, with returns close to 50%. Economic growth in Europe and Spain is driving both the fund and the Madrid stock market. EWP has a moderate 0.54% expense ratio, which makes the fund a relatively inexpensive way to get non-U.S. exposure, albeit in a concentrated way.
EWP uses a representative sampling strategy to track the MSCI Spain Index, which means the fund doesn't own every stock in the index. In fact, by several measures, the fund is not very well diversified. In addition to the risks involved in a fund with single-country exposure, three stocks -- Banco Santander, Telefonica, and Banco Bilbao Vizcaya Argentaria -- account for half the fund's assets. The fund also has roughly 70% of its assets in three sectors: financial, utilities and telecom. This confluence of concentration makes EWP an extremely focused and risky fund.
Spain's stock market has boomed this year, and the Ibex 35 Index is up more than 30% so far. That rising tide has helped lift EWP. Spain's gross domestic product grew by more than 3% in 2005, the best performance of any large European nation. The European Commission expects the Spanish economy to grow 3.4% in 2007. If this growth occurs, it will be on the back of a string of 11 consecutive quarters of GDP increases. Of course, if either the market or the GDP fails to perform as expected, the fund is likely to take a hit.
Before grabbing this bull by the horns, there are a few things you should consider. The euro is up nearly 30% in the past four years. Just like stock markets do not rise forever, neither will the euro. Right now, the trend is up for both Spanish stocks and the euro, but the strength of the currency may eventually reduce exports and help slow economic activity. Another point to consider is that imports have been rising in Spain, fueling a current account deficit that is now larger, in percentage terms, than that of the U.S. In addition, Spain is not immune to terrorist activities, and the Basque terrorist organization Euskadi ta Askatasuna (ETA), which declared a cease-fire in March 2006, recently breached that cease-fire by stealing a large quantity of weapons in France, raising the potential for more violence to come.
If you are looking for a diversified fund, this one isn't it. On the other hand, if you are willing to take on a risky and potentially volatile fund, EWP might be an option for a small portion of your investment pie. After such great returns in 2006, don't be surprised if returns for EWP in 2007 are lower. However, the European market does seems to be shaking off its long-term lethargy, and Spain looks well-positioned to take advantage of this new prosperity. Maybe this bull does have some legs.
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Fool contributor Zoe Van Schyndel lives in Miami and enjoys the sunshine and variety of the Magic City. She does not own any of the funds or stocks mentioned in this article. The Motley Fool's disclosure policy is hearing music from another time.
