We at Toroso are proud to play a role in the ETF democratization of access to markets for everyone, but this outcome produces expected performance which is driven by a stated discipline. (Ever ask for an index methodology guidebook?) In that regard, in this week’s TETF.index update we focus on Europe, which ironically seems to be going through its own liberal definition of democratization, i.e. Spain (Exit of Prime Minister Mariano Rajoy) and Italy (Giuseppe Conte is now the new Prime Minister of Italy).
Eurozone investor sentiment deteriorated sharply in June, probably reflecting the recent volatility and political uncertainties in the Spanish and Italian economies. The measure of confidence compiled by Sentix plunged to 9.3, down from 19.2 in May, marking the lowest score since October 2016. Fears of a trade war with the U.S. are also not encouraging for the Europeans. The tourism industry may be the strongest source of growth this summer, so those from the U.S. traveling to Europe should spend generously knowing their dollars are going farther.
Of course, hindsight is 20/20 and, we often say “the markets will make you humble.”However, with about nearly 116 ETFs across $73 billion to choose from, European security selection can really make a difference. We agree that diversification has its benefits, but with a sense of irony and respect we suggest worrying less about fees in this decision and more about the decision about currency exposure and or ETF methodology. To that point – “Structure Matters” and simply comparing the $18 Billion Vanguard FTSE Europe ETF (VGK), the $12 Billion iShares MSCI Eurozone ETF (EZU), and the $1.7 Billion iShares EU Hedged (HEZU), the iShares outcome is historically very different – much greater than the 10 Bps in fees. Further to the point, for an extra 3 Bps, historically you can own the currency hedge on the same index (HEZU is literally EZU + currency hedge) and would have seen a meaningful difference in outcomes during different periods (See chart below).
We have added HEDJ to the list because the team at WisdomTree (WETF) basically invented the hedged strategy, but we must compliment Blackrock for making it simple. Innovation is at the core of the asset management industry, and while there will always be closures, new launches will remain the next generation of opportunities for those who recognize that markets are dynamic and evolving.
We understand that U.S. investors tend to allocate according to a neutral currency stance, but we live in a “Buy, Sell or Hold” world, and by opting out of a currency call we would argue an investor is in fact making a traditional market call on the currency. Put simply – Blackrock’s decision to wrap EZU in HEZU, which includes the hedge, has led to about a 200 basis point difference in returns over these past 3 years.
Flows are arguably a telling sign, but without knowing who the buyers and sellers are, it can also be misleading. Nevertheless, ETFs do serve as a short term tactical sentiment indicator which for now looks to be net negative of about $3.24 billion in the month of May. This brings us to the question again– how does an investor manage the risk that Europe is a value trap? Answer: Benchmark your choice against the largest and lowest cost ETF available, the Vanguard Europe ETF (VGK), and take the challenge of trying to add alpha through security selection. Look beyond the 10 Bps of savings. Of course, history may not repeat itself and past performance is not indicative of future performance, but where does it read that future innovation or tactical decision making around these new volatile markets won’t necessarily outperform a product that was created in 2005. Ever buy a computer that is 13 years old?