Once Mighty Britain Tumbles, Its ETF Sinks

Oh, how far the mighty have fallen.

Last year, the United Kingdom was still coasting on an uninterrupted growth cycle that began in 1992. It averaged annual GDP growth of 2.5% for years. In September, the British pound hit a high of $2.03. Many expected the British economy to kick into overdrive and reach a 3% increase for 2007.

Then came the credit crisis, a troubled housing market and a reduction in consumer spending. British residents depend more heavily on credit than even U.S. citizens, and they're hurting. The pound has slipped and economists' outlook on the British economy has become as perky as a cold, rainy London day.

In the world of exchange traded funds, iShares MSCI United Kingdom Fund recently has been bearing the weight of the slump.

Assets

This almost 12-year-old exchange traded fund has $1.2 billion in assets and tracks the performance of the MSCI United Kingdom Index. It returned nearly 30% in 2006. Thanks to the rough financial waters toward the end of 2007, though, its return was just 8% last year.

While single-country funds tend to be risky, this fund has been doing particularly poorly of late.

What happened? High oil prices helped keep British inflation at an annual rate of 2.1% in November, higher than the Bank of England's 2% target. The retail sector also has been hit hard, after experiencing what retailers called the worst Christmas season in years. The Bank of England last week froze interest rates at 5.5% in anticipation of slowed economic growth and higher inflation. Of the fund's 155 holdings, several have been a big drag on performance. Hardest hit, not unexpectedly, are those in the financial field.

Banks Going Down

Royal Bank of Scotland , the fund's eighth-largest holding, has been diving since Oct. 31. The bank's shares fell more than 3% Thursday on fears it might follow U.S. banks and raise more equity to shore up its capital base.

HSBC Holdings , the fund's third-largest holding, also is a laggard. The bank's stock plummeted Tuesday to a 26-month low after a research report estimated the banking giant would have to write off $13 billion for subprime losses. Goldman Sachs this week downgraded the financial giant to a "conviction sell."

British officials are turning to other nations to help stem the flow of red. On Thursday, U.K. Chancellor of the Exchequer Alistair Darling was expected to meet with the financial ministers of France, Germany and Italy and push for more international coordination on anticipating and responding to turbulence in financial markets.

Oil slipped to $90 a barrel this week, which hurt the fund's largest holding, BP , and its fourth-largest holding, Royal Dutch Shell . BP was downgraded this week to neutral.