In the European Central Bank’s latest meeting, they delivered another bout of firepower in their ongoing attempt to get Europe out of its malaise and prevent deflation from creeping back into the picture. Among its latest measures, the ECB announced a cut to its benchmark rate to 0.15% from 0.25%, while the bank also slashed the deposit rate from zero percent down into negative territory, -0.1%, a first for a major central bank.
Effectively, this means that banks will be paying to keep money at the ECB, a move that looks to nudge banks to lend out their capital to businesses. This is pretty much uncharted territory, though it is worth noting that the negative interest rate policy was tried out in both Sweden and Denmark with mixed results, but it remains to be seen how such a massive economy like the euro zone will react to these new measures (see all the European Equity ETFs here).
At least initially, the move was pretty positively received by the markets as European stocks moved higher across the board. The euro, as represented by (FXE - ETF report) , also strengthened against the dollar, though one has to wonder how long this trend can last, especially if the recent moves boost inflation across the euro zone region.
Though it should be noted that inflation levels have fallen to near zero levels across the euro zone, this move by the ECB, or a further push into negative deposit rate territory, could definitely hit the euro’s value when compared to the greenback. On the other hand, if the measures do help to boost sagging growth and inspire confidence that the central bank really will ‘do whatever it takes’ to keep the euro zone together, it could act as a catalyst for further euro strength.
Either way, ETFs that hedge out euro exposure, but target companies in the region, look to be heavily impacted by these trends. These funds will either prove their worth during this rocky time for the euro zone, or they will greatly underperform should the euro strengthen against the dollar (read Forget Europe’s Currency Risks with These Hedged ETFs).
Below, we highlight some of the top choices in the space that investors who are focused in on this negative deposit rate policy should pay close attention to in the coming months as this historic shift trickles down into the market:
WisdomTree Europe Hedged Equity Index Fund (HEDJ - ETF report)
This is easily the most popular way to play Europe in a hedged fashion, as this fund has over $1.5 billion in assets under management. The product follows the WisdomTree Europe Hedged Equity Index, holding about 120 stocks in its portfolio.
The ETF has heavy exposure to the consumer industries, industrials, and financials, leaving little for telecoms, energy, and technology. For nations, Germany (25%), France (24%), Spain (18%) and the Netherlands (15%) dominate the holdings list.
HEDJ has underperformed its main unhedged competitors, (VGK - ETF report) and (EZU - ETF report) , over the past two years, but in recent times, it has easily beaten out these funds. And should the euro tumble from here, this fund could be an excellent choice for dollar denominated investors (also read Inside the New Currency Hedged ETFs from iShares).
German Hedged Equity ETFs
Investors currently have two choices in this space which follow German stocks but take out the euro exposure. Germany is often a popular choice for this hedging since the country has a very strong economy and it does a lot of exports. Thus, it can benefit from a lower euro, though its economy is still comparatively robust.
The top funds here are (DXGE - ETF report) and (DBGR - ETF report) , both of which have a few dozen German companies in their portfolios. For both funds, consumer, financials, basic materials and industrials take the top four spots from a sector perspective, while large caps take the lion’s share from a cap look.
Once again, longer term metrics favor the unhedged version of the German ETF investing which in this case is the ultra popular (EWG - ETF report) . However, shorter term figures show EWG underperforming its hedged counterparts, and this trend may continue if recent ECB measures drag the euro down.
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Author is long EWG.