If the euro falls apart, it goes without saying that chaos will ensue. Government and bank defaults could easily follow, for a start. But how would this impact on exchange-traded products that track euro-related indices?
If you are looking to bet on a fall in the euro, the good news is that you can do so with exchange-traded currencies (ETCs). ETF Securities’ short euro/long US dollar and short euro/long pound ETCs (LSE: SEUR and URGB) allow investors to gain from any drop in the euro’s purchasing power. Of course you can do the same thing with a spread bet, but ETCs are safer (they are collateralised) and much less volatile. All-in expenses are about 1% a year (that’s the management fee plus the daily spread), while it costs 20-40 basis points in a bid-offer spread to trade.
How would a euro breakdown impact on exchange-traded funds (ETFs) that track European stocks? The thing to remember is that many share and bond indices select only from member countries of the single currency. The Euro Stoxx 50 index, the most widely followed share benchmark among European ETFs, is a good example.
Why does this matter? Because if an individual country left the euro, then local shares and bonds would be redenominated into a new national currency that would almost certainly devalue sharply. The index providers would also be forced to kick those shares and bonds out of euro-only indices. While shares in riskier euro member countries have already fallen to discount currency strains to an extent, selling out of them straight after a currency crisis would almost certainly be the worst time to do so. So it may be worth avoiding indices that are likely to be forced sellers.
Finally, be aware that if the euro breaks up, it is likely to make the counterparty and collateral risks that lie below the surface of many ETFs far more important. You wouldn’t want to hear over a weekend that Italy and Spain were leaving the euro, then learn on Monday that your FTSE 100 tracker had been collateralised with Italian and Spanish banks – whether as backing for derivatives contracts or in securities lending. There’s no way of being 100% sure you won’t be hit, short of finding trackers that don’t use derivatives or lend stocks. But the more transparent an issuer is about its holdings and collateral policies, the better.
• Paul Amery edits www.indexuniverse.eu