EUFN: iShares MSCI Europe Financials ETF

EUFN: iShares MSCI Europe Financials ETF

The iShares MSCI Europe Financials (NYSEARCA: EUFN) exchange-traded fund (ETF) was created in 2010 to track the performance of the MSCI Europe Financials Index, which is composed of financial companies of developed market countries in Europe. Since the fund's creation, EUFN has demonstrated an average annual return of 2.17%.

The financial sector in Europe has been hit hard as a result of the financial crisis in 2008. Many central banks resorted to accommodating monetary policies. The European Central Bank (ECB) cut the benchmark interest rate several times from 2010 to 2015 and initiated an asset purchase program in 2015. As a result of these actions, net interest margins for European banks shrunk substantially. However, as the pace of economic activity in Europe begins to pick up, European financial institutions are expected to regain ground and show an increase in profits. EUFN presents an appealing opportunity for investors to profit from the rebound in the European financials sector.

EUFN invests in equities of financial institutions with a wide geographic dispersion. The fund has concentrated holdings of U.K. financial companies with 31% allocation, while Switzerland has the second-largest allocation at 12%. The fund also invests in other developed European countries, such as Germany with 11% allocation, Spain with 10% and Italy with 7% allocation.

EUFN invests predominantly into European banks that account for the 52% of the fund's holdings. Other industries, such as insurance and diversified financials, account for 26 and 15%, respectively. Real estate companies have about 6% allocation. The top five holdings of EUFN account for 25% of the fund's invested assets and are HSBC Holdings PLC, Banco Santander SA, UBS Group Registered AG, Allianz SE and Lloyds Banking Group PLC. No single company has more than 9% allocation, and the fund's top 10 holdings have 41% allocation.

Characteristics

EUFN was created on Jan. 20, 2010, and it is managed by BlackRock Fund Advisors. The fund employs a passive investment strategy by using representative sampling. While EUFN rebalances its portfolio from time to time to make it more similar to the underlying index, the fund does not sell or buy stocks to take advantage of market swings. The fund has an expense ratio of 0.48%, which is in line with its peers.

EUFN is traded on the New York Stock Exchange Arca, and investors can purchase the fund's shares through investment brokers.

Suitability and Recommendations

Regulation and compliance costs for the financials sector increased dramatically since the financial crisis of 2008, leading to plummeting profitability for European financial institutions. European banks are required by the ECB set aside more capital to cushion against negative shocks and to perform annual stress tests. Also, the litigation costs for European financial institutions increased dramatically as a result of numerous wrongdoings committed by banks. Investors should be well-aware of current regulatory development for the European financial sector before investing in EUFN.

Many major Western European countries are expected to show robust growth due to lower petroleum costs, the depreciation of the euro and the ECB's expansionary monetary policy. Also, as Greece is likely to stay in the eurozone, the fears of financial contagion subsided, leading to more stable economic environment within Europe. These positive developments should benefit the expected returns of EUFN.

According to modern portfolio theory (MPT), EUFN is most suitable for a growth investment strategy due to the European financials sector benefiting from the economic rebound in Europe.

As of August 2015, EUFN demonstrated a lot of volatility and below-average returns over the last five years. The five-year standard deviation was 23.6%, while the average annual return was 4.4%, resulting in the five-year Sharpe ratio of 0.3, which is significantly lower than the Sharpe ratio of 1.34 for the S&P 500 Index. This is primarily attributed to increased compliance and litigation costs for the European financial institutions.

EUFN is most appropriate for investors interested in gaining exposure to the European financials sector with a high degree of diversification across numerous industries within the sector. Due to its exposure to a single sector and foreign markets, investors should include EUFN as part of the broadly diversified portfolio.