Spanish Election Highlights Risk of Country Funds

Is the victory for the Socialist Party in Spain also a win for exchange-traded funds over closed-end funds?

Shares of the closed end-fund, the Spain Fund (SNF), dropped 83 cents, or 8.22%, to $9.27, as a result of the Socialist Party's upset victory in Spain's national election Sunday, as well as concerns that last week's terror attacks in Madrid were the work of al Qaeda instead of a Basque separatist group.

The fall in SNF shares was 65% greater than that of the exchange-traded fund that tracks the iShares MSCI Spain index (EWP), which was down 4.96%. That raises the oft-heard question as to the relevance of closed-end funds that concentrate on single countries in the face of a growing ETF market.

Don Cassidy, Senior Research Analyst at Lipper, thinks the controversy between closed-end funds and ETFs, as well as the selloff in Spanish markets, are short-term overreactions.

Cassidy says the unexpected Socialist victory in Spain was a vote out of anger as opposed to economics because it came on the heels of a terrorist attack. He questions whether the new government has a mandate over the longer term to make serious economic changes.

On the whole, Cassidy views the Spanish vote as the "equivalent of a change" from President Bush to Democratic challenger Sen. John Kerry, except that the Socialist party in Spain is further to the left.

From the perspective of a U.S. investor, Cassidy thinks the jitters about the fund -- as evidenced by trading volume Monday 10 times its daily average -- will subside quickly as well.

"Generally, U.S. investors tend to overreact to changes in foreign governments, unless they are very familiar with the country," says Cassidy. "It's not as though the new government is going to turn Spain into a communist country," says Cassidy. "I think a 5% decline says people understand that."

One of the advantages of the Spain ETF vs. the closed-end fund in this particular case is the lower beta, says Ron DeLegge, publisher of EtfMarket.com.

"The Spain CEF has a beta of 1.24 verus the Spain iShares ETF which has a beta of only 0.73, so the Spain ETF has lower volatility," says DeLegge. "This difference helps explains the volatility discrepancy between the two funds. The top three investment sectors in order for both respective funds are the same: financials, telecom, and utilities."

In the battle between closed-end funds vs. ETFs, Lipper's Cassidy says single-country closed-end funds have a legitimate place in a person's portfolio, but that investors might want to look for funds that trade at a discount to their net asset value. Prior to today's selloff, shares of the Spain Fund were trading at an 8% premium to the fund's NAV. Today's drop in price puts SNF shares on par with NAV.

Morningstar analyst Bill Rocco suggests retail investors avoid both emerging-market ETFs and closed-end funds, due to their risky nature.

"Usually both these vehicles are very concentrated in a few sectors and are subject to a great deal of political risk like we saw today in Spain," says Rocco.

More from Personal Finance

This Should Be Your Retirement Savings Plan When the Stock Market Crashes

This Should Be Your Retirement Savings Plan When the Stock Market Crashes

Former General Electric CEO Jack Welch Has 4 Tips to Getting a Promotion

Former General Electric CEO Jack Welch Has 4 Tips to Getting a Promotion

What Is Neymar's Net Worth?

What Is Neymar's Net Worth?

How to Make a Fortune Like Microsoft Billionaire Founder Bill Gates

How to Make a Fortune Like Microsoft Billionaire Founder Bill Gates

Goldman Sachs' Marcus Service Has What Other Fintech Firms Don't

Goldman Sachs' Marcus Service Has What Other Fintech Firms Don't