ETFs Designed For ECB’s Bond Buying Binge

All eyes are on the European Central Bank’s Jan. 22, 2015 meeting, as it’s no secret that ECB President Mario Draghi has been hinting at a large-scale quantitative easing program for some time.

There’s no guarantee the ECB will actually implement any such program in January, but the consensus seems to be that there will be some type of big announcement on that front sometime in the first quarter of 2015.

At the same time, the U.S. Federal Reserve is expected to begin raising rates in mid-2015. This opposing force between the world’s two largest central banks has strategists calling for a currency-hedged strategy to capitalize on a rising-equity/falling-euro scenario in Europe.

An Equity ETF Designed For A Weakening Euro

For currency-hedged options, the $5.6 billion WisdomTree Europe Hedged Equity Fund (HEDJ | B-47) is by far the leading ETF in the space.

Despite its “Europe” name, HEDJ focuses exclusively on eurozone securities. That means that for better or worse, it excludes the U.K., Switzerland and Sweden, which account for roughly 50 percent of Europe’s equity market capitalization, combined.

More importantly, it carries a significant exporter bias, attempting to capitalize on a weakening-euro scenario. The dividend-weighted ETF does this by screening out any company that gets more than 50 percent of its revenues from within Europe.

This makes HEDJ geared toward investors with a strong bearish view on the euro. Naturally, the fund favors consumer sectors over financials compared with vanilla, cap-weighted European indexes (MSCI Europe IMI Index).

This now-blockbuster fund tracks its index well and trades more than $80 million a day at 3 basis point spreads, keeping overall trading costs very low.

‘Neutral’ Currency-Hedged Products

Contrary to popular thinking, investors interested in currency-hedged Europe ETFs don’t necessarily have to be bearish on the euro. They might have a neutral view, and simply prefer a purer equity exposure by taking any currency fluctuations out of the equation.

The Deutsche X-trackers MSCI Europe Hedged Equity ETF (DBEU | B-66) is also a leading ETF in the space, and takes a broader approach, including all of developed Europe, beyond the eurozone.

It tracks a cap-weighted index and neutralizes exposure to the euro, the British pound, the Swiss franc and a few other European currencies against the dollar. DBEU has more than $710 million in assets and trades with robust liquidity that’s sufficient for small and large investors alike.

For a neutral currency take on the eurozone, rising in popularity is the iShares Currency Hedged MSCI EMU ETF (HEZU), which literally holds the $7.5 billion iShares MSCI EMU ETF (EZU | A-63) with a forward contract overlay to neutralize euro exposure.

Since its launch in July, HEZU has already amassed more than $60 million in assets. Liquidity isn’t robust, at least not yet, but trading HEZU is manageable with the use of limit orders.

Finally, Deutsche X-trackers recently launched a eurozone version of DBEU in early December. The Deutsche X-trackers MSCI EMU Hedged Equity ETF (DBEZ) casts a wider net than HEZU by including small-caps and covering 99 percent of the eurozone’s total market cap (HEZU only covers large- and midcaps).

DBEZ may be another option for those who aren’t fans of the “fund of funds” structure of HEZU, or for those who think small-caps will see big upside in a eurozone equity rally.

Unhedged European Majors

For those who aren’t interested hedging currencies, or think the euro’s fall has run its course, you can’t go wrong with the majors in the space.

The $11 billion Vanguard FTSE Europe ETF (VGK | A-98) and iShares’ EZU provide solid cap-weighted coverage of their respective markets, both track their indexes remarkably and have ultra-deep liquidity. The main difference between them is, of course, that VGK targets Europe while EZU targets only eurozone nations.

For large-cap-focused investors, the SPDR EURO STOXX 50 ETF (FEZ | A-64) tracks the most famous euro-focused index in the world, the Euro Stoxx 50 Index. This large-cap ETF has more than a decade of trading history and has close to $4 billion in assets.

A Small-Cap Blockbuster

I’d be remiss if I didn’t mention the top-performing Europe ETF since Draghi’s “whatever it takes” speech in July 2012: the $700 million WisdomTree Europe SmallCap Dividend Fund (DFE | C-71).

DFE holds more than 1,000 small-caps from all of Europe, and carries a tiny $1.6 billion weighted average market cap. Despite its small-cap focus, DFE trades at trailing earnings of only 16.13, giving it a deep value tilt, compared with the neutral MSCI Europe Small Cap Index, which trades at trailing earnings of 26.81.

There is currently no hedged Europe small-cap ETF, though I wouldn’t be surprised to see one launch in the coming years.

Performance

Here are the returns and volatility of the funds since Draghi’s “whatever it takes” speech in 2012. I used a start date of Aug. 1, 2012, because that speech marked a turning point for European equities, and was a game changer for the eurozone.

(Note: HEDJ changed its index to its current eurozone-hedged strategy on Aug. 30, 2012, meaning there’s a month of data overlap from HEDJ’s prior strategy).

Source: Stockcharts.com

Data from 8/1/2012-12/30/2014

Eurozone 2015

I’m not going to try to predict in what phase of Draghi’s “whatever it takes”-induced European equity recovery the market now is. That said, I think most would agree that ballgame is probably not over yet.

Clearly, Europe faces head winds. We have uncertainty once again in Greece, with elections set for Jan. 25.

Any quantitative easing program in the eurozone could also look different from what we saw from the Federal Reserve and the Bank of Japan.

Looking Ahead

Furthermore, there’s no guarantee that eurozone stocks would even rally on such an announcement either, especially if the program falls short of what European share prices already reflect.

But for investors who think Draghi will deliver, and want to position themselves for more stimulus from the ECB, there are now a multitude of ETF choices at their disposal.

The main choices mostly come down to whether or not to be hedged, and whether to go Europe or eurozone. Since July 2012, it seems unhedged/eurozone plays have been the winner.

But it remains to be seen if this trend will continue in a post-eurozone QE world.

At the time this article was written, the author held a long position in HEZU. Contact Dennis Hudachek at [email protected], or follow him on Twitter @Dennis_Hudachek.