iShares' New Euro Hedged ETF Needed
Last Thursday, BlackRock launched its iShares Currency Hedged MSCI EMU ETF (HEZU) to compete in the hedged European equity space that's been gaining traction.
In 2014 alone, the WisdomTree Europe Hedged Equity ETF (HEDJ | B-45), the veteran in the space, has pulled in more than $1.2 billion, catapulting its total assets under management to $1.9 billion.
HEZU's other competitor, the db X-trackers MSCI Europe Hedged Equity (DBEU | B-52), has pulled in $186 million this year, which, considering DBEU's $7.9 million in assets at the start of the year, that's fund growth of 2,350 percent in just seven months!
European equities, especially from the eurozone, have been on a tear since European Central Bank President Mario Draghi's "whatever it takes speech" back in July 2012. Speculation is now mounting about whether the ECB will eventually engage in outright quantitative easing.
The eurozone is battling deflationary pressures, and it's no secret the ECB would like to see the euro weaken from its current highs. The idea is that any further stimulus measures would keep the equity rally intact while keeping a lid on further euro appreciation.
So what makes HEZU one of a kind and different from its competitors? Several factors, besides its unique fund structure.
HEZU literally holds iShares' blockbuster exchange-traded fund, the $11 billion iShares MSCI EMU ETF (EZU | A-62), with a forward-currency-contract overlay to neutralize any euro exposure.
Structurally, it's identical to iShares' suite of other currency-hedged ETFs, which I've written about extensively. In a nutshell, by holding a highly liquid ETF as its core constituent for creation/redemption purposes, it boosts the fund's block liquidity and keeps trading costs low.
From an exposure perspective, HEZU provides vanilla, cap-weighted exposure to large- and midcap securities from eurozone nations by holding EZU.
WisdomTree's HEDJ, which I consider to be HEZU's main competitor, is anything but plain vanilla.
While the dividend-weighted HEDJ also offers eurozone equity exposure, it screens out companies that don't get more than 50 percent of their revenues from outside of Europe. This naturally tilts HEDJ heavily toward exporters.
DBEU is a cap-weighted fund that holds large- and midcap stocks from all of Europe, as opposed to the eurozone. Non-euro countries like the U.K., Switzerland and Sweden make up close to 50 percent of the fund's weighting. Keep in mind their respective currencies are also hedged, along with the euro.
HEDJ's multilayered methodology and DBEU's comprehensive coverage of Europe create very different portfolios from HEZU from a country sector perspective, which is likely to produce disparities in their returns.
Country Breakdown (%) | |||
UK | 0 | 0 | 33 |
France | 31 | 25 | 14 |
Germany | 30 | 25 | 14 |
Switzerland | 0 | 0 | 13 |
Spain | 12 | 20 | 6 |
Netherlands | 10 | 15 | 5 |
Sweden | 0 | 0 | 5 |
Italy | 8 | 2 | 4 |
Denmark | 0 | 0 | 2 |
Belgium | 4 | 8 | 2 |
Finland | 3 | 3 | 1 |
Sector Breakdown (%) | |||
Financials | 23 | 13 | 22 |
Industrials | 15 | 23 | 11 |
Consumer Cyclicals | 13 | 16 | 11 |
Health Care | 9 | 12 | 13 |
Basic Materials | 9 | 6 | 7 |
Consumer Non-Cyclicals | 8 | 17 | 12 |
Energy | 7 | 1 | 11 |
Telecom | 6 | 6 | 5 |
Utilities | 6 | 3 | 4 |
Technology | 5 | 5 | 3 |
Source:ETF.com
The good news is that all three funds offer something different. A quick and easy way to choose the right fund for you could be in two simple steps.
HEZU Vs HEDJ Vs DBEU
The first step is determining whether you want hedged equity exposure to Europe or the eurozone. If you want all of Europe, DBEU is your only option, so that's easy.
If you're looking exclusively for eurozone exposure, between HEZU and HEDJ, it boils down to whether you want vanilla eurozone coverage without euro exposure (HEZU), or whether you're expecting the euro to depreciate and you want to capitalize on that (HEDJ).
HEDJ is specifically tilted toward exporters. In some respects, it's deliberately attempting to capitalize on a falling euro scenario by juicing returns from its exporter-focused holdings.
HEDJ's strategy could certainly pay off if the euro weakens, but it does create significant sector tilts that can work for or against the fund. For example, compared with HEZU, HEDJ is stacked up in industrials and consumers, but is underweight in financials.
Nouriel Roubini is one macroeconomist who expects large-scale asset purchases by year end, but told us in a recent Alpha Think Tank interview that he thinks banks could rally once they've successfully recapitalized.
Clearly, HEDJ is the established play here. It trades more than $20 million a day at 4 basis point spreads. It charges the highest of the three funds, with a 0.58 percent expense ratio, but it tracks its index well, generally trailing it by only 0.33 percent over rolling 12-month periods.
HEZU is the newbie and has some catching up to do. It charges less than HEDJ, with a 0.51 percent expense ratio. While on-screen volume might be thin at first, HEZU's block liquidity should be solid, since it holds the highly liquid EZU (see my blog on HEWG on how this structure absorbs large trades).
If 2013 was the breakout year for yen-hedged Japan ETFs, 2014 is gearing up to be the year for euro-hedged ETFs. I wouldn't be surprised to see interest build in these funds, as speculation—including large-scale asset purchase—builds around the ECB's next moves.
At the time this article was written, the author held no positions in the securities mentioned. Contact Dennis Hudachek at dhudachek@etf.com, or follow him on Twitter @Dennis_Hudachek.
