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Be Careful With Euro Hedged ETFs

The most successful asset gathering ETF during the first quarter of 2015 has been the WisdomTree Europe Hedged Equity, a currency hedged way to get exposure to the eurozone. While the hedging theme has helped Deutsche and iShares international equity products gather inflows, the approximately $10 billion that flowed into HEDJ is more collected by the next two most popular ETFs thus far in 2015. http://www.etf.com/etfanalytics/etf-fund-flows-tool

We think HEDJ has two main aspects that have supported strong investor interest. HEDJ aims to hedge or neutralize exposure to fluctuations in the relative value of the euro against the U.S. dollar. This has been particularly important in 2015, as the euro fell 11% year to date through March 30. Secondarily, stocks inside HEDJ are dividend payers that derive 50% of revenues from outside of the eurozone. As such, they could be beneficiaries from the weaker euro, which makes local companies more competitive.

HEDJ has climbed 20.0% year to date through March 30, ahead of the 7.8% gain for iShares MSCI EMU ETF (EZU), which is unhedged and holds the largest companies domiciled in the eurozone regardless of their revenue streams. Deutsche X-trackers MSCI EMU Hedged Equity (DBEZ) and iShares Currency Hedged MSCI EMU (HEZU), two currency hedged ETFs that track the same MSCI index as EZU, rose 19.8% and 19.3%, respectively.

The 50% of revenues aspect of HEDJ has resulted in different sector exposures compared to EZU, HEZU and DBEZ. Most notably is the WisdomTree's 23% stake in consumer staples, which is double the 11% weighting for the iShares and Deutsche EMU offerings. Meanwhile financials exposure (11%) for HEDJ is half that of its peers.

Distinct Sector Exposure for Popular Eurozone ETFs

Source: S&P Capital IQ, March 29, 2015

We think it is easy to make the case that with a weaker euro, HEDJ's exposure to exporters is a positive -- and many investors have done so. However, S&P Capital IQ thinks investors need to look deeper at the holdings. In ranking approximately 800 equity ETFs, we leverage S&P Capital IQ equity analysts' opinions on the holdings.

S&P Capital IQ thinks the euro will remain under pressure as the U.S. Federal Reserve looks to raise rates, though the decline might not be as strong as it has been in the first quarter. However, we think investors need to be careful when reviewing European ETFs and understanding not just whether they are hedged.

S&P Capital IQ has research and rankings on the above ETFs. Visit http://trymsatoday.com/ to see the full article and/or view our ETF reports.

Follow me on Twitter at @ToddSPCAPIQ

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