How Catalonia Dispute May Impact Spain ETFs

Declared illegal by the Spanish government, Catalonia, one of Spain’s 17 autonomous communities held a referendum on Oct 1 for independence from Spain. Of the 2.3 million votes cast, 2 million backed independence, per government spokesman Jordi Turull. However, Spanish PM Mariano Rajoy said that the vote holds no legitimacy.

Since it was never a question of securing a majority percentage support, primarily because those against the separation refrained from voting altogether, referendum activists had said that securing about 1.8 million votes would be enough to declare independence.

What Lies Ahead if Separation Goes Through?

A prospective independence for Catalonia will be a major blow to both the parties economically. Most importantly, Catalonia contributes to 19% of Spain’s GDP while 16% of Spain’s population lives in Catalonia.

Economists feel a prospective breakup of the region would cause massive loss in jobs and income. Moreover, just garnering enough support to breakup from the region is not enough. With separation comes huge monetary and opportunity cost.

A potential separation will result in a huge blow to Catalonia, as over 35% of its exports are to the Spanish market. Moreover, massive cost in terms of setting a separate government will be a huge factor in predicting the future of the state.

Adding to the agony, Catalonia accounts for over 16% of Spain’s debt. If separated, what Catalonia will be required to do in terms of assuming the massive portion of the entire nation’s debt is difficult to predict.

Moreover, Catalonia does not hold the right to automatic membership of the EU. In order to retain its trading rights, EU members must give a unanimous decision to grant Catalonia trading rights. This includes a ‘yes’ from Spain, which is highly unlikely. Almost 66% of Catalonia’s exports are to the EU and will be at risk if it separates without a confirmed seat in the EU.

The process is still at its early stages. Hence assuming anything would be difficult. However, on the eve of the referendum, the euro declined, while there was great selling in Catalan bonds and stocks as well owing to the massive uncertainty in the markets.

Let us now discuss a few ETFs focused on providing exposure to Spanish equities (see all European equity ETFs here).

iShares MSCI Spain Capped ETF EWP

This fund seeks to provide exposure to large and mid-cap equities in Spain.

The fund manages AUM of $1.53 billion and charges 48 basis points in fees per year. Financials, Industrials and Utilities are the top three sectors of the fund, with 43.6%, 17.5% and 10.0% allocation, respectively (as of Sep 29, 2017). From an individual holdings perspective, the fund has high exposure to Banco Santander (MC:SAN) SA, Banco Bilbao Vizcaya Argentaria and Telefonica (MC:TEF) SA, with 20.5%, 10.3% and 8.7% allocation, respectively (as of Sep 29, 2017). It has returned 25.7% year to date and 26.4% in a year (as of Sep 29, 2017). EWP currently has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook.

Let us now compare the performance of this ETF to a broader Europe based ETF, FEZ.

SPDR EURO STOXX 50 ETF FEZ

This fund seeks to provide exposure to equities in the European region.

The fund manages AUM of $4.55 billion and charges 29 basis points in fees per year. From a geographical perspective, the fund has high allocation to France, Germany and Spain, with 36.3%, 32.8% and 10.6% exposure, respectively (as of Sep 28, 2017). Financials, Industrials and Health Care are the top three sectors of the fund, with 22.9%, 13.6% and 11.2% allocation, respectively (as of Sep 28, 2017). From an individual holdings perspective, the fund has high exposure to Total SA (PA:TOTF), Siemens AG (DE:SIEGn) and Sanofi (PA:SASY), with 4.7%, 4.1% and 4.0% allocation, respectively (as of Sep 28, 2017). It has returned 23.0% year to date and 26.4% in a year (as of Sep 29, 2017). FEZ currently has a Zacks ETF Rank #1 (Strong Buy) with a Medium risk outlook.

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