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Europe Equity ETFs Gain On Recovery Hope

Cinthia Murphy

European equities ETFs have been very popular in recent months, consistently raking in fresh assets month after month, as investors express confidence that Europe has indeed emerged from its worst recession since the eurozone was formed 14 years ago.

The turnaround began in earnest in the summer of 2012, when the European Central Bank finally made it clear that, like the Federal Reserve in the United States, it would be the lender of last resort for deeply indebted countries in southern Europe such as Greece. The situation stabilized rather quickly after that, and has morphed into a slow recovery that ETF investors have picked up on.

Improving economic indicators like retail sales and demand for manufactured goods in the region show strengthening consumer confidence, even while unemployment rates remain steady and government spending in general remains tight.

Greece, which fell the hardest, has bounced back the most dramatically since the ECB took its stand, even if recovery is slow and not yet assured. But, by most measures, Germany has been the driver of that growth and, more recently, the United Kingdom’s recovery has been surprising on the upside.

“The macroeconomic environment in Germany has displayed signs of stabilization and potential for stronger growth in months ahead,” WisdomTree’s Director of Research Jeremy Schwartz said in a recent blog. “Barring any policy missteps by the European Central Bank and peripheral growth faltering, we believe that Germany is on track to continued economic improvement.”

A look at the iShares MSCI Germany ETF ( EWG | A-96 ) shows the extent of the rebound—EWG has now climbed about 19 percent year-to-date and upward of 25 percent in the past 12 months. The fund has also attracted a net of $1.88 billion in new assets since May alone, pushing its total assets to more than $5.3 billion today.

Meanwhile, the Global X FTSE Greece 20 ETF ( GREK | F-6 5)—the only ETF in the market to offer pure exposure to Greek equities—has seen total returns of 27 percent year-to-date, and in the past three months alone, the fund has rallied a whopping 46 percent, according to IndexUniverse data.

The chart below shows GREK’s trajectory to recovery, having forged a bottom in the summer of 2012, all the while the euro, as measured by the performance of the CurrencyShares Euro ( FXE | A-97 ), which tracks the value of the euro relative to the U.S. dollar, has been gradually rising as well.




The Turning Tide

In the first nine months of the year, more than $14 billion of assets flowed into European equity ETFs, and since May, the segment has seen solid net inflows every single month. That’s already more than three time the flows seen in the same year-earlier period, and significantly more than the $9.7 billion in inflows seen in the entire 2012, according to BlackRock data released late last month.

There are only a handful of ETFs on the market today that set out to capture the entire developed Europe total equity market, and about 50 other funds that slice and dice European equities either by country or by region—such as emerging Europe—or by sector or segment, such as financials. Funds like EWG, GREK and FXE, for instance.

No ETF is bigger than the Vanguard FTSE Europe ETF ( VGK | A-95 ), which has now $11.6 billion in assets following what has been one of 2013’s top-10 year-to-date ETF inflows of $4.86 billion, as well as positive market performance, according to data compiled by IndexUniverse. VGK has posted year-to-date total returns of more than 19 percent.

The fund, which first came to market in 2005, comprises some 400 developed Europe securities, excluding small-cap firms. About a third of its portfolio is allocated to the U.K., followed by roughly 14 percent allocations to France, Switzerland and Germany, each—some of the very countries that have been economic growth leaders in the region.

One of VGK’s most notable distinctions is its cost—the fund is the cheapest European ETF, with an annual expense ratio of 0.12 percent, or $12 for each $10,000 invested. It’s also the most liquid among its peers, making it a home run with investors looking for European exposure.

ECB Takes A Stand

That exposure began looking more prospective in the summer of 2012 after European Central Bank Head Mario Draghi finally assured markets that the ECB, much like the U.S. Federal Reserve, would serve as the lender of last resort for debt-ridden countries in the eurozone, alleviating concerns surrounding economies such as Greece, Spain and Italy.

That reassurance was enough to change the tone in the region, and allow for a slow-moving recovery to take hold, at first, in the so-called periphery of Europe’s largest economies, and later, more broadly. Just today, for instance, the Bank of Spain reported Spain saw its first quarterly GDP growth in more than two years, while the euro neared a 23-month high against the dollar—all the latest signs of a European recovery that’s slowly forging ahead, even if not assured at this point.

And unlike the U.S. where the Fed is still printing a great deal of money in an effort to spur growth and keep borrowing costs low, the Europeans are “mopping up” liquidity because they have a more demand-driven system, Merk Funds currency expert Axel Merk told IndexUniverse recently.

“They are tightening in Europe, and that’s why the euro is doing well relative to the dollar,” Merk said, noting that fiscal policies in the region are making European equities more attractive.

Other ETFs that have benefited from the growing interest in Europe include the iShares MSCI EMU ( EZU | A-60 ), which, like VGK, has ranked as one of the most popular ETFs in the market in recent months, attracting a net of $3.66 billion in net new assets year-to-date.

Boasting $6.5 billion in total assets now, EZU is different from VGK in that it excludes companies from any European country that does not use the euro—countries like the U.K., Switzerland and Sweden, which happen to be some of the biggest allocations in VGK, while France and Germany top the country exposure at about 30 percent each.

This distinction tilts the 233-security fund’s exposure somewhat away from the broader market, but it can also in a way appeal to the more currency-focused investors by eliminating exposure to any currencies beyond the euro.

EZU is also significantly pricier than VGK, with an expense ratio of 0.53 percent, but the fund has also seen slightly higher year-to-date total returns than VGK—about 21.9 percent—according to data compiled by IndexUniverse.

iShares is also behind what’s perhaps the broadest European equities ETF, the iShares Europe ETF ( IEV | C-96 ), which holds some 350 stocks of companies in both developed and emerging Europe—17 countries in total make up the portfolio. The U.K. leads the portfolio’s country allocation with a weighting of 33 percent, followed by a nearly 15 percent allocation to France.

The $2.2 billion ETF isn’t cheap to own, coming with an expense ratio of 0.60 percent, even if it trades efficiently at 3-cent average spreads. So far this year, IEV has seen total returns of 19.3 percent amid net inflows of $1.18 billion in the period.

Competing closely with IEV is the SPDR Euro Stoxx 50 ( FEZ | C-61 ), albeit a far smaller portfolio compared with its counterparts, including only 50 of the largest European companies.

Like EZU, it also excludes any security from countries that don’t use the euro, which makes the portfolio heavily exposed to France and Germany. But the $3.7 billion fund is among the most liquid in the segment, and it also comes with a relatively low price tag of 0.29 percent in expense ratio, and a 3-cent average trading spread.

Financials represent about a quarter of the portfolio’s sector allocation, followed by industrials and consumer cyclicals. FEZ has seen total returns of nearly 21 percent year-to-date.

There are also currency-hedged strategies like the $444 million WisdomTree Europe Hedged Equity ETF ( HEDJ | D-40 )—strategies that pull risks associated with currencies out of the investment equation.

The fund targets dividend-paying firms in a strategy that focuses heavily on export-focused companies—the same companies that would benefit most from a weaker euro relative to other currencies such as the U.S. dollar.

That’s to say that in an environment where the euro is strengthening, such as is the case this year, HEDJ would likely underperform a similar fund that’s not currency-hedged. That might explain why HEDJ is up a more modest 16.7 percent year-to-date, while competing funds in the segment have seen upward of 20 percent in gains in the same period.

Half of HEDJ’s 120-security portfolio is split between France and Germany, with another third split between the Netherlands and Spain. Industrials and consumer cyclicals are the fund’s largest sector allocations, with financials coming in third, with a 15.7 percent weighting.

Charts courtesy of StockCharts.com

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