Europe is riding high on a wave of Central Bank liquidity and a falling euro, which has boosted markets and sent demand for European equity ETFs soaring. It is one of the most crowded markets for ETFs - around 20 per cent of the 775 London-listed ETFs are European equity products. But with such a wide range of indices all offering exposure to different parts of the European market, which is right for you?
Core indices
If you want broad exposure to European equities there are several index options and a reasonable divergence between them.
MSCI Europe is one of the broadest, spanning 15 developed markets in Europe and has 439 constituents. Major consumer corporates and healthcare companies such as Nestlé and Novartis make up its top holdings, although it is reasonably diversified in sector terms. Financials makes up 22 per cent of the portfolio, consumer staples 13 per cent and healthcare 13 per cent.
However, it does dedicate a large chunk of its portfolio to the UK - 31 per cent - which could be an issue for investors worried about doubling up their UK exposure with both FTSE trackers and European.
By contrast, the EURO STOXX 50 offers exposure to just 50 blue-chip stocks from 12 eurozone countries, including Austria, Belgium, France, Germany and Greece. According to Adam Laird, passive investment manager at Hargreaves Lansdown, it is "good if you want the flexibility to get in and out" as it is one of the most liquid indices in the eurozone. It is also good for those keen to take a higher risk for potentially higher rewards - in recent years it has tended to outperform other indices on the upside, but fallen further on the downside.
The index with the largest number of stocks is the STOXX Europe 600, which invests only in so-called supersectors, including financials, retail and insurance, across 18 countries in Europe. The largest single exposure in the Stoxx 600 is to UK-based private equity group 3i.
Performance (% total return) of core European indices in GBP
| European core indices | 2015 | 2014 | 2013 | 2012 | 2011 | 2010 | 2009 | 2008 |
|---|---|---|---|---|---|---|---|---|
| EURO STOXX 50 GTR in GB | 3.95 | -2.11 | 25.90 | 16.10 | -15.34 | -5.39 | 16.79 | -23.41 |
| FTSE Developed Europe TR in GB | 4.38 | 0.22 | 23.88 | 14.93 | -10.50 | 7.68 | 22.28 | -25.14 |
| MSCI Europe TR in GB | 4.27 | -0.34 | 22.91 | 13.89 | -10.39 | 7.14 | 20.93 | -25.82 |
| STOXX EUROPE 600 E TR in GB | 4.54 | 0.55 | 24.63 | 15.52 | -10.37 | 8.25 | 22.55 | -25.52 |
| Core European indices | Focus | Top 10 Holdings (%) | Number of Stocks | Lead sector | YTD performance (% total returns) |
|---|---|---|---|---|---|
| FTSE Developed Europe ex UK Index | large and mid-cap companies | 23.63 | 389 | Financials 22% | 8.87% |
| Euro Stoxx 50 | Blue-chip, super sector leaders | 38.38 | 50 | Financials 25% | 13.64% |
| Stoxx 600 Index | Large, mid and small | 17.6 | 600 | Financials 23% | 14.28% |
| MSCI Europe | Large, mid-cap | 18.12 | 439 | Financials 22% | 8.82% |
The smart approach?
If certain elements of the main indices concern you, for example too much exposure to financials or the potential volatility of stocks, you could attempt to iron out those issues with a more specialised approach. A proliferation of indices has developed to support the growing market in so-called smart-beta ETFs, which use a rule-based system to isolate certain parts of common indices, most commonly the lowest volatility stocks, highest value or growth stocks.
The MSCI Europe Minimum Volatility Index was established two years ago to reduce investors' exposure to volatility within the parent index. It uses a risk model to select only stocks with low measures of standard deviation. It has a lower exposure to financials than its parent index, as well and higher exposure to Switzerland, and instead of Nestlé has gold mining company Randgold Resources as its top constituent. The iShares MSCI Europe Minimum Volatility UCITS ETF (IMV) tracks this index for the low cost of 0.25 per cent.
Comparable risk of MSCI low volatility ETF and core index
Annualised standard deviation (%) | Sharpe ratio (%) | |||||
| 3yr | 5yr | 10yr | 3yr | 5yr | 10yr | |
| MSCI Europe Min vol (EUR) | 8.47 | 8.81 | 11.2 | 2.14 | 1.59 | 0.65 |
| MSCI Europe | 10.01 | 12 | 14.75 | 1.65 | 1.07 | 0.44 |
The EURO STOXX Low risk Weighted 50 represents the least volatile companies from the parent index. Ossiam Europe Minimum Variance Index also targets volatility, but reflects the performance of a dynamic selection of the 300 most liquid stocks from the STOXX Europe 600 Index.
Other smart-beta indices include the SG European Quality Income Index, which targets stocks likely to distribute high levels of dividends.
If you are keen to take more risk to gain potentially higher returns, small-cap indices could also be for you. The MSCI Small Europe Cap Index has returned historically much higher figures than its comparable indices but during downturns has fallen by higher amounts.
Funds like SPDR MSCI Europe Small Cap UCITS ETF (EUSC) and db X-trackers MSCI Europe Small Cap Index UCITS ETF DR (XXSC) have both delivered strong returns over and above the MSCI Europe over a five-year period.
Comparable performance of small-cap indices and core index
| Small-cap funds (GBP returns) | 1-mth | 3-mth | 6-mth | 1-yr | 3-yr | 5-yr |
|---|---|---|---|---|---|---|
| DB X-Trackers MSCI Europe Small Cap Index UCITS ETF (DR) 1C GBP TR in GB | 2.69 | 8.36 | 6.67 | -0.19 | 53.86 | 64.77 |
| SSgA Europe SPDR MSCI Europe Small Cap UCITS ETF in GB | 1.85 | 7.11 | 5.80 | -0.84 | 53.31 | 63.79 |
| Index : MSCI Europe TR in GB | 1.70 | 4.77 | 2.19 | 3.88 | 35.39 | 35.71 |
Source: Morningstar as at 13 March 2015
Currency hedging your bets
With the euro rapidly depreciating as a result of QE, currency hedging is a key thing to think about when investing in European indices. Sterling rose 1 per cent to hit €1.40 for the first time since December 2007 last week and the euro hit a fresh 12-year low against the dollar, dipping under $1.06. Commentators recommend choosing an ETF that tracks a hedged index such as the MSCI EMU 100% Hedged to GBP Index.
Mick Gilligan, head of fund research at Killik & Co, recommends the UBS MSCI EMU hedged GBP UCITS ETF (UC60). He says: "The benchmark index captures the large and mid-cap institutions across the eurozone, weighting them by market capitalisation with monthly rebalancing.
"We believe financing conditions are improving and we anticipate that the drop in the euro will help stimulate the eurozone economy and, in turn, the sentiment and the prospects of companies within the portfolio."
The portfolio is hedged back to sterling through a rolling one-month forward contract and pays a gross dividend yield of 3.2 per cent (historic), which can be either accumulated or distributed. The ongoing charges are 0.33 per cent.
Christopher Aldous, managing director of Charles Stanley Pan Asset, says: "UBS EMU Hedged is the primary European candidate. It has some good exposures as it is mainly the larger countries and is hedged."
Lyxor also became the first ETF provider to offer investor currency-hedged ETF share classes based on the Euro Stoxx 50 index last month with its Lyxor UCITS ETF EURO Stoxx 50 Monthly Hedged C-GBP (MSEX), with an ongoing charge of 0.20 per cent.
