ETF Showdown: Comparing European Equity ETFs

[This article compares two ETFs that track European equities. It was first published in the September issue of ETF Report UK, our quarterly magazine for UK financial advisers]

Why Invest In European Equities?

European equities have been the focus of ongoing debate for investment managers, advisers and investors for many years now: the region bore witness to the choppy markets of the credit crisis and then the Eurozone crisis of 2011, which saw peripheral countries' bond yields spike and equity markets tank. Don't forget that in 2013, Cypriots were queueing at cash points, scaring markets about the region's stability. Most recently there has been further turmoil in 2015—as we write, the Greeks are still hammering out a deal on debt relief, prompting speculation about a "Grexit."

There has never been a truly solid foundation for the eurozone in recent times, and the UK looks set to hold a referendum on whether it wants to be part of the bloc in 2017.

However, many European markets have been producing higher returns than the FTSE 100, as well as higher yields. UK advisers would do well to pick their European equity exposure carefully, regardless of their own "Brexit" politics.

What Options Exist For Investing In European Equities?

We will focus on two ETFs that track this equity market:

• db X-trackers Euro Stoxx 50 UCITS ETF (XESC)
• iShares MSCI EMU UCITS ETF (CEU)

The Euro Stoxx 50 Index may well be the default option for many advisers, but it is worth considering the alternatives in European equities.

What Indices Do They Track?

The db X-trackers is tied to an index of 50 stocks spread across seven countries in Europe, and therefore is rather concentrated. This index was the first one to be used to launch a European equity ETF over a decade ago; therefore, advisers are likely to be very familiar with this strategy.

The iShares fund tracks a much wider breadth—243 companies across 10 countries in the European Economic and Monetary Union (EMU). The EMU was enshrined in the Maastricht Treaty of the early 1990s and was intended to promote further economic integration and coordination between its members.

Are The Indices Concentrated In Certain Sectors?

Despite a big difference in the number of underlying constituents for each index, the broad geographical and sector exposure for the two funds is quite similar.

The db X-trackers fund has more than 35% in France, with 31% in Germany and 12% in Spain. Italy, the Netherlands, Belgium and Finland are the other four countries in the index. When it comes to sectors, more than 26% are in financials, with 18% in consumer goods.

The iShares fund is slightly less concentrated in France, at 31.8%, and Germany, at 29.6%. Ireland also makes up a small proportion—1.2%—of the exposure. Sectorwise, financials and consumer discretionary again make up the heaviest weights, at 23.9% and 14.7%, respectively.

The top holdings are the same. French pharmaceutical company Sanofi, German pharmaceutical firm Bayer and global energy company Total make up around 9 to 12% of both funds. So, although the fact sheets stress that financials are the top weighting, investors are also taking a heavy bet on European drug firms.

That said, there is still a hefty presence in European banks, like Spanish bank Banco Santander, which are infamously volatile.

How Do They Replicate The Index?

Both ETFs are physically replicated, meaning the ETF manager will go directly into the market and buy the underlying securities, instead of using derivatives to mirror the index.

How Much Do They Cost?

While costs on Euro Stoxx 50 ETFs have plummeted in recent years, as many of these funds are packaged into low-cost, so-called core ranges from providers, the same cannot be said of alternative indices which track European equities.

The db X-trackers fund has an all-in fee of just 0.10%, while the iShares alternative is 0.33% per year.

How Do They Compare On Liquidity?

At first glance, both funds are liquid and fairly diversified. Even if, for example, Greece is kicked out of the eurozone, the contagion risk in the rest of Europe is minimal, and unlikely to prompt the ETF to tank in value.

Fund size also comes into play. CEU has grown to €1.4 billion in assets under management since it came to market in 2010. This compares to a whopping €4.3 billion in XESC since it launched in 2009, making it one of the largest ETFs in Europe.

When it comes to trading on the London Stock Exchange, CEU trades a monthly value of around £1 million to £5 million, with a jump to £56 million in March. The number of trades are quite small, falling between 40 in March and just 13 trades in July, suggesting larger investors are making up most of the buying and selling activity.

For XESC, trading hit a peak of £1.3 billion in January, but settled between £200 and £600 per month until July 2015. Again, trading numbers were higher per month for this ETF, at around 130 to 200 trades.

There may be more liquidity in the form of over the counter trading between institutions, but this data from the exchange is all that retail investors can access.

XESC seems to be more liquid, based on this data. It is reflected in the bid/offer spread, with XESC on a 0.08% spread, and CEU on 0.15% as of 17 July.

How Have They Performed?

Both funds are in positive territory over one year and three years. CEU, however, is the clear winner over both categories, at a very happy 22.1% for both periods in euro terms. Deutsche Bank's more concentrated fund has only produced 6% over one year, but brought in 17% returns over three years in sterling terms.

On liquid indexes, tracking difference is barely noticeable, especially with the funds producing such positive returns and if the trade is of a retail size.

Is One Better Than The Other?

The answer can hardly be black and white, and will depend on the adviser client's risk appetite and objectives.

For traders, XESC is larger and seemingly more liquid in terms of number and value of trades. It is also by far the cheapest.

However, CEU has produced better returns, especially over one year. It is also much less concentrated regarding the number of underlying constituents, which may prove important during times of uncertainty in Europe. The question is whether you're willing to pay almost four times as much to buy it.

What Other Options Do I Have?

As for alternative ETFs for this space, there are at least 15 versions of the Euro Stoxx 50 in Europe from providers like Lyxor, BNP Paribas, Source and Ossiam, which are mostly all cheap and liquid. Lyxor’s fund is the largest in Europe at over €7.7 billion AUM, but its annual cost is more pricy at 0.2%. iShares also offers a Euro Stoxx 50 ETF for just 0.10% fees, a mite pricier than the db X-trackers fund.

Veering away from the Euro Stoxx 50 comes with a price tag. ETFs tracking alternative European equity indexes see their fees suddenly jump to around 0.25 to 0.30% per year and have higher trading costs. In that case, it becomes very important to shop around.