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Is This a Better Europe ETF?

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The European economy has finally turned around with reduced debt concerns, considerable growth in some key nations like the U.K., Germany and France, a stronger currency and respectable economic data at regular intervals.
All major nations in the Eurozone – France, Germany, the Netherlands, Italy and Denmark-- emerged out of recession last year. Markit’s Flash Eurozone Composite Purchasing Managers Index (PMI), which measures overall business activity, grew to 53.2 in January, the fastest clip in two and a half years, suggesting that the region is well on track to recovery.
Strength in the manufacturing sector exhibited the fastest expansion since May 2011. The German PMI is hovering at a 32-month high level while reduction in French PMI moderated. Struggling regions like Greece and Spain are also recording steady growth in manufacturing activity.  
Investors should, however, note that recovery is still in its nascent stage and things are not yet out of the woods as deflationary risks loom large with credit growth data for December recording a month-on-month shrinkage.  The present inflation level at 0.7% (at the end of January 2014) remains well behind the ECB target of 2.0%.
However, as per ECB, the retrenchment in December credit growth might be a seasonal phenomenon as banks intended to clean their balance sheets prior to an ECB review and stress tests for 2013. The ECB also anticipates a rise in demand across all loan categories for the first quarter of 2014.
Thus, though the region is still to attain sustainable growth, just the end of a long-run recession is in itself great news. Investors are also turning more positive on the continent.
Thus, given the region’s slow-but-assuring fundamentals, a look at the top ranked ETF in Europe, or even just some countries in the Eurozone could be a good idea, especially based on our Zacks ETF Ranking system (read: Play a Resurgent Europe with These ETFs).

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box or asset class (Read: Zacks ETF Rank Guide). Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while they also receive one of three risk ratings, namely Low, Medium or High.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of the five ranks within each risk bucket. Thus, the Zacks ETF Rank reflects the expected return of an ETF relative to other products with a similar level of risk.

For investors seeking to apply this methodology to their portfolio in the European equities space, we have taken a closer look at the top ranked FEP. This ETF has a Zacks ETF Rank of 1 or ‘Strong Buy’ (see the full list of top ranked ETFs) and is detailed below:

FEP in Focus
Launched in April 2011, First Trust Europe AlphaDEX Fund ETF (FEP) looks to offer enhanced exposure to the Defined Europe Index before fees and expenses which is a modified equal-dollar weighted index (read: Top Ranked Europe ETF in Focus: EZU).
The benchmark is designed by the S&P to objectively identify and select stocks from the S&P Europe BMI Index that may generate positive alpha relative to traditional passive-style indices through the use of the AlphaDEX selection methodology.
All the component stocks in a benchmark are ranked separately on both growth factors like price appreciation, sales to price and one-year sales growth as well as value factors including book value to price, cash flow to price and return on assets.
The top 200 ranked stocks in the benchmark are then divided into quintiles and each stock is weighted and ranked equally within each quintile with top rated stocks getting more assets.
The fund, though not among the most popular ones in the Europe equities space, has decent assets of about $504.8 million. Its trading volume of around 170,600 shares a day also suggests modest liquidity.
The choice is a bit costly with 57 basis points in fees a year which is slightly higher than the average expense ratio in the Europe equities space. Its enhanced approach has helped to increase the price, though it could be worth it for some investors.
FEP Portfolio
With 199 stocks in its basket, this fund from First Trust puts only 8.93% of its total assets in the top 10 holdings with no company accounting for more than 1.04% of the total, suggesting very low concentration risk. Top companies include Faurecia, Piraeus Bank S.A. and Valeo S.A., three of which account for around 3.07% of the assets.
In terms of sector exposure, the top allocation, financials, comprise a little greater than one-fifth of the total assets followed by consumer discretionary companies making up around 17.78%. Beyond this, industrials (17.54%) and utilities (10.8%) round out the top four, while Healthcare (1.34%) gets the least weight.
As far as country allocations go, France takes up the top spot with 18.65% of the total closely followed by the U.K. at 17.55%. Germany with about 11.28% of the assets fills up the third place.  
Style-wise, the fund has a nice mix of value and growth stocks. The fund is well-diversified capitalization wise as well, with mid caps grabbing 45% share of assets followed by large caps (39%). FEP is also a good tool for international diversification as it has a low correlation with the S&P 500 Index as indicated by an R-squared of 25.1% against the S&P 500.
The fund has returned around 22.54% over the last one year (as of January 30) surpassing the biggest European fund by assets Vanguard FTSE Europe ETF’s (VGK) 14.5% return. The fund is currently hovering a little lower than the 52-week high. FEP pays out a yield of 1.56% per annum.
Bottom Line
This ETF is appropriate for investors looking for a targeted bet on European stocks but with a cautious stance. Given the AlphaDEX methodology, equal-weighted approach, tilt toward stronger nation – all indicate that FEP has a relatively low risk outlook. Notably the U.K. economy – FEP’s second largest allocation – is now expanding at the fastest pace since 2007.
Just one word of caution, the fund is unhedged, making it vulnerable to any weakness in the Euro which has more than 60% exposure, though recent trends suggest that this doesn’t look to be too much of an issue in 2014 (read: Forget Europe's Currency Risks with These Hedged ETFs).
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