Given the crisis in Ukraine, a broad Europe-focused ETF makes more and more sense.
This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features James Breech, president and chief executive officer of Toronto-based Cougar Global Investments.
In March, we broadened our exposure to Europe away from some of the single countries such as Germany we had been favoring, as we felt a need to diversify, given the European recovery and, more recently, the evolving crisis in Ukraine.
Choosing the iShares Europe ETF (IEV | C-96) in favor of, say, the iShares MSCI Germany ETF (EWG | B-97), was a decision that ran counter to what we have been moving toward in the past several years; namely, a more granular approach to asset classes given the way increasingly specific indexes were increasingly associated with very liquid ETFs built around those indexes.
Before delving more deeply into IEV, I want to be clear that we continue to believe our more targeted approach makes sense, though it does have its limits.
So it goes that in the emerging markets, we are only invested in Mexico through the iShares MSCI Mexico Capped ETF (EWW | B-95) and in South Korea via the iShares MSCI South Korea Capped ETF (EWY | C-93).
And while we would own single-country Europe-focused funds such as EWG or the iShares MSCI United Kingdom ETF (EWU | B-94), we chose not to get exposed to a prospective recovery story such as Ireland’s. That's because the underlying fund, the iShares MSCI Ireland ETF (EIRL | D67), isn't sufficiently liquid for our requirements as we invest at least 5 percent in any one asset class.
A New Approach To Europe
The process that led to our purchase of IEV in March began last fall, when we decided to explore the possibility of reversing one area of our recent direction of investing in narrower asset classes.
We were looking for a way to diversify beyond Germany and the U.K. and to potentially gain exposure to some non-euro equity markets and currencies.
As the Ukrainian crisis developed in the first quarter, we accelerated our efforts to find the best index and corresponding ETF vehicle to remain exposed to European equities.
We remained steadfast in our need for any underlying securities to be sufficiently liquid. So our research started as it always does, with the various indexes, before making a decision regarding which ETF to use to replicate the behavior of the index.
The index that most closely matched our investment criteria was the S&P Europe 350 Index, a market-cap-weighted benchmark of 350 of the largest European companies. The top 10 holdings are Royal Dutch Shell, Nestle, Novartis, Roche, HSBC, Total, BP, GlaxoSmithKline, Sanofi and Banco Santander.
While other ETFs in the same category as IEV met our liquidity requirements, we preferred the country exposure in IEV’s index more than the competing products.
Specifically, we were able to retain exposure to the U.K. and Germany at 33 percent and 13 percent, respectively—an important consideration considering those two economies have continued to outperform the eurozone as a whole.
In addition, we added equities covering companies headquartered in France (15 percent), Spain (6 percent), the Netherlands (4 percent), Italy (4 percent) as well as South Africa, Portugal, Luxembourg, Greece, Finland, Guernsey and Ireland.