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ETF picks for the European markets

Three portfolio managers offer ways for Canadians to beef up on the Continent


Date: May 21, 2015

The phoenix has risen from the ashes of Europe’s once-broken economies. Stock prices are up almost 20 per cent year to date.

To capitalize on new investor zeal for the old Continent, providers of exchange-traded funds have launched new offerings listed on the TSX and elsewhere. If you want broad-based, low-cost exposure to Europe’s recovery, consider these picks from three ETF experts:

Alan Fustey, portfolio manager at Index Wealth Management, Winnipeg

About a half-dozen ETFs that focus on European markets have been released in the past year or so, Mr. Fustey says. For long-term investors, he recommends those from the larger firms such as Vanguard and iShares, whose Canadian-listed ETFs emulate the performance of broadly based, underlying European indexes.

iShares MSCI Europe IMI Index ETF (TSE:XEU): Seeking to replicate the performance of the MSCI Europe Investable Market Index, this ETF from iShares provides broad investment in the European market at low cost. Its year-to-date performance is 18 per cent. With a management expense ratio (MER) of about 0.25 per cent, it gives Canadian investors exposure to about 960 companies listed publicly on 15 European markets. Launched in April last year, its top holdings are Nestlé SA, Novartis AG and Roche Holding AG, multinationals that benefit from global growth. “The XEU holds large, medium and some small-cap companies, so you’re getting a very broad spectrum of the European equity market,” Mr. Fustey says.

Vanguard FTSE Developed Europe Index ETF (TSE:VE): Tracking the performance of the FTSE Developed Europe Index, this Vanguard ETF also provides broad exposure to Europe’s larger publicly traded companies. Its year-to-date performance is 16 per cent. Launched in June last year, its MER is 0.23 per cent, and its top holdings are virtually identical to the iShares offering, but it tracks only about 530 companies. “This one doesn’t include small cap firms like iShares’ XEU, but if you’re looking for a broad-based investment in Europe’s top companies, this does the trick,” Mr. Fustey says.

One caveat: Neither of these offerings is hedged to the Canadian dollar, so if the loonie rises in value against the euro, performance of the underlying holdings will be muted. (Both fund companies also offer hedged versions.)

Graham Westmacott, portfolio manager with PWL Capital, Waterloo, Ont.

Investors seeking to eliminate currency volatility can choose from a couple of new hedged offerings, Mr. Westmacott says. Moreover, these ETFs screen stocks using metrics and other means aimed at enhancing returns over passive ETFs that emulate the performance of underlying indexes, he says.

BMO MSCI Europe High Quality Hedged to CAD Index ETF (TSE:ZEQ): Launched last year, this ETF from the Bank of Montreal is hedged to the Canadian dollar. Its year-to-date performance is 13 per cent. With a MER of 0.45 per cent, it tracks more than 120 holdings listed on the MSCI Europe Quality 100 per cent Hedged to CAD Index. The index tracks only large publicly traded European firms that have low debt levels, high returns on equity and stable year-over-year earnings growth, among other metrics. Mr. Westmacott says this selection strategy may pay off for long-term investors, as recent “research suggests stocks with a higher-than-average quality factor will yield a higher return.”

First Trust AlphaDEX European Dividend Index ETF (CAD-Hedged) (TSE:EUR): Value investors can earn a pure dividend play on European stocks with this offering, which has a MER of 0.66 per cent and includes only 42 holdings. Its year-to-date performance is 14 per cent. Tracking the performance of the AlphaDEX European Dividend Index, all holdings are also traded on the New York Stock Exchange as ADRs (American Depository Receipts). Top positions in this ETF, which was launched last year, are software company NICE Systems Ltd. and Teva Pharmaceutical Industries Ltd. (both Israeli companies), and Britain-based Prudential Corp. PLC. This ETF’s dividend yield is about 2.14 per cent.

Mr. Westmacott warns that because the BMO ETF screens for quality using metrics, it may experience higher turnover, which can result in higher taxes, than passive index-based offerings. And while the First Trust ETF provides exposure to large blue-chip firms, it can be highly concentrated in certain sectors – about 20 per cent of its holdings are in energy, for example – that may result in more pronounced negative returns during some years.

Larry Berman, portfolio manager with ETF Capital Management, Toronto

Investors willing to look to U.S. stock markets can find sector- and country-specific ETFs if they’re bullish on a particular aspect of Europe’s diverse economy, Mr. Berman says. Or they can choose a broader investment strategy, a global ETF that automatically provides exposure based on Europe’s market size relative to the rest of the world.

iShares Currency Hedged MSCI Germany ETF (NYSE:HEWG): Tracking the performance of large and mid-cap German companies, this iShares ETF has a MER of 0.53 per cent. Its year-to-date performance is 20 per cent. Launched in 2014, it hedges the euro against the U.S. dollar, and Mr. Berman says eliminating currency risk may be prudent given the U.S. economy is expected to outperform Europe. “I still believe the euro will go below parity to the U.S. dollar over the next year or so as the ECB continues to focus on stimulus that will in turn weaken the value of the euro versus stronger currencies,” he says. A falling euro will also benefit the German economy, which generates about 50 per cent of its GDP from exports.

BMO MSCI All Country World High Quality Index ETF (TSE:ZGQ): Mr. Berman says most investors should have some weighting in their portfolios toward the European market – bullish or not – because Europe makes up about 20 per cent of the global economy. One simple solution is choosing a broad-based global ETF providing a default allocation based on Europe’s market size relative to other markets. This BMO ETF was launched in November on the TSX with a MER of 0.52 per cent. Its year-to-date performance is 11 per cent. It invests in a diversified basket of large global stocks, weighting companies from each region based on market capitalization and other metrics. “It’s a smart ETF that involves quality screening, like ZEQ for Europe,” Mr. Berman says. “About 68 per cent of its stocks are U.S, but it’s got top holdings from the U.K., Switzerland, Denmark and other European countries.”

A few caveats: Much of Europe’s upside has already been priced into its markets, Mr. Berman says, so investors jumping on the bandwagon may have already missed out on the big gains. Moreover, Europe still faces many problems, including the prospect of Greece defaulting on its debts and leaving the euro zone. “Europe’s problems aren’t going to be fixed easily, so I don’t think anyone should overweight their portfolio in it right now.”

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