A good time for German equity ETFs?

But commentators argue that the market has fallen too far and that nervousness is creating a solid buying opportunity for those keen to buy German equities at good value.

German equities at good value?

Germany's main index, the DAX 30, fell by 6 per cent from peak to trough in just over two days following the People's Bank of China decision to devalue the yuan last week. That was a dramatic turnaround from earlier in the year, when it was among the best-performing markets in the world, hitting an all-time high in April 2015.

But Robert Smith, investment manager at Baring German Growth (GB0000822576), says the dip is not a cause for concern. He says: "The reaction to these external factors has been overdone. We have therefore used the most recent market dip as a buying opportunity by deploying our cash. While the currency devaluation came as a surprise, unnerving markets, it was comparatively small, with the yuan depreciating against the euro by just 2.3 per cent.

"For the companies that we are invested in with sizeable export sales to China, the currency movement has not fundamentally changed the investment case. We do not believe the stronger euro to yuan rate of exchange has reached a level that would significantly erode these companies' competitiveness. In fact, we would note that in the year to date the yuan has appreciated by 13.5 per cent against the euro."

It is not the first time this year that commentators have been eyeing the DAX due to wider market movements. It is heavily tied to the fate of the eurozone and a weak euro makes it a solid value play. Peter Sleep, senior portfolio manager at Seven Investment Management, says: "There are two strands pulling German stocks. There is the European economic recovery, assisted by European QE (quantitative easing) and the weak euro, all of which should be boosting European equities.

"On the other hand, the slowdown in China could hit big exporters such as the German car companies. The DAX is more industrial, export-orientated and more exposed to a cyclical slowdown if the slow trend in China continues."

Adam Laird, head of passive investments at Hargreaves Lansdown, says: "We are positive on European equity, which we think looks cheap compared with other developed markets and Germany is more for value seekers than others. It is an interesting market with manufacturing and engineering (including chemicals, automobile and electronics) an important part."

In the past month, the DAX has lagged behind the MSCI AC Europe index, dropping by 3.3 per cent compared with 2 per cent for the European benchmark. However, over 10 years, the German index has trumped the European one, returning 132.5 per cent compared with 75.3 per cent.

Your options

Despite the region's popularity with wealth managers, there are few ETFs tracking the German market. Db-x trackers DAX UCITS ETF (DR) (XDDX) was the first ever ETF based on the DAX to list in London, launched on the London Stock Exchange in August 2013. There are now just five unleveraged ETFs tracking German equities available to UK investors.

Both db-x trackers DAX UCITS ETF (DR) and Lyxor DAX (DR) UCITs ETF (DAXX) track the highly liquid DAX index and give investors access to the largest German companies. But the DAX is a limited index, comprising just 30 companies. Both ETFs have fallen in recent months, but in 2015 both delivered positive returns. Bayer AG accounts for more than 10 per cent of both ETFs.

Mr Laird says the Amundi ETF MSCI Germany (CG1), is a more diverse ETF. He says: "With a total expense ratio of 0.25 per cent, this is more expensive than the Lyxor or Deutsche Bank ETFs, but the MSCI Germany index is much more diversified, covering 54 companies. This might be considered by investors who want the lower risk of a broader exposure. However, note that it is synthetically replicated." In calendar-year terms the ETF has delivered similar returns to the Deutsche Bank DAX ETF.

There are also two new ETFs aiming to isolate specific aspects of the market in order to deliver better returns. One is the db x-trackers Mittelstand & MidCap Germany UCITS ETF (XDGM). The ETF tracks the Solactive Mittelstand & MidCap Deutschland Index, composed of 70 small- and medium-sized enterprises selected for their focus on niche market segments, long-term outlook and close ties between founders, management and company. The index increases weights to companies with management stakes of more than five per cent and excludes companies from the banking, insurance and diversified financials sector. Smaller companies tend to outperform over the long term, making this an interesting play. The fund was only launched in 2013 so does not have a long track record but has delivered impressive returns so far in 2015.

Christopher Aldous‎, managing director at Charles Stanley Pan Asset, says: "We do like the Mittelstand ETF as it allows us to diversify our exposure to Germany. One of the advantages is that the Mittelstand index is likely to be held for more fundamental reasons (than holders of the DAX) and is less likely to be sold just to reduce short-term equity exposure. It has a good exposure to industrial goods manufacturers (27 per cent), which should be benefiting from the euro's recent weakness and it has outperformed the Dax by 9 per cent over the past month."

The second selective ETF is also the newest. The WisdomTree Germany Equity UCITS ETF GBP Hedged (DXGP), launched two months ago, is the only currency-hedged German equity ETF and invests in companies that paid out at least $5m in cash dividends on shares of common stock in the previous year and derive less than 80 per cent of their revenue from inside Germany. The focus on exporters could mean its stocks feel the pain of reduced demand from China in the future. But the ETF could protect investors if the pound strengthens when UK interest rates rise.

Prices and market cap of German equity ETFs

Performance (cumulative total return %) of German ETFs

Source: FE Trustnet, as at 17 August 2015