Summary With over $5 billion in assets, can it withstand the headwinds of a stronger dollar? With major firms that export from Europe in this ETF, is it a good place to invest as a hedged vehicle in 2015? We answer these questions and analyze one of the largest hedged Euro ETFs in the marketplace. The WisdomTree Europe Hedged Equity ETF (NYSEARCA: HEDJ ) is a $5.5 billion fund that seeks to track the price and yield performance, before fees and expenses, of the WisdomTree Europe Hedged Equity Index, with a symbol of (WTEHIP). According to WisdomTree, The underlying Index and Fund are designed to have higher returns than an equivalent non-currency hedged investment when the value of the U.S. dollar is increasing relative to the value of the euro, and lower returns when the U.S. dollar declines against the euro. The Fund will invest in stocks of European companies with significant revenue from exports. In terms of the criteria to determine what is significant revenue from exports, we reviewed the index selection process from WisdomTree. According to WisdomTree, the universe is composed of the largest-dividend paying companies from the WisdomTree DEFA Index (broad developed world ex-U.S.) that are traded in euros, with a minimum capitalization of $1 billion and at least 50% of revenues derived from outside Europe. The fund hedges its currency exposure by entering into one-month forward contracts and rebalancing at month-end. What we find very attractive is the revenue being derived elsewhere in the world for these euro region based firms and a hedge that is rebalanced every month. Currently, the fund has 126 holdings, plus 23 (22 short and 1 long) currency contracts, while the index has 129 holdings. In order to properly analyze this ETF, we analyzed the market cap of the components, style breakdown, the various country exposures, sector and industries, and credit risks. The market cap of the components is quite simplistic and represents the export nature of the companies in the ETF. HEDJ Market Capitalization Market Cap Weight Large 83.50% Mid 11.60% Small 4.100% Micro 0.80% The market cap is indicative of large export driven companies and would be a natural fit for an ETF of this magnitude. As we mentioned in our recent article on the SPDR Dow Jones REIT ETF (NYSEARCA: RWR ), Morningstar uses a slightly different weighting for their categories and breaks this ETF down as follows: Giant 59.11%, Large 29.34%, Medium 10.46%, and Small at 1.09%. It is interesting that there is over 11% in mid-cap firms that can fulfill the minimum capitalization and export requirement of the index and fund. In terms of style characteristics of the portfolio, it is also a rather simple breakdown as follows: HEDJ Style Style Weight Growth 44.60% Value 33.80% Blend 19.60% As noted, many of the large companies in the portfolio continue to have growth characteristics in spite of the sluggish and recessionary growth in the euro region. Combining them with the large value companies in the ETF, along with blended firms, produces an attractive style mix for this ETF. In terms of the currency exposure, it is 100% euro with no U.K. pound sterling or other eurozone currencies. One of our websites we use for data, xtf.com states that is it is 100% U.S. dollar and does not factor in any currency exposure. We will discuss this later in our analysis. In terms of the country exposure, it has quite an interesting mix as follows: HEDJ Country Exposure Country Weight Germany 25.82% France 25.41% Spain 18.71% Netherlands 9.21% Belgium 8.54% United Kingdom 5.54% Italy 1.11% Luxembourg 0.81% Austria 0.74% Switzerland 0.60% Portugal 0.34% United States 0.09% Ireland 0.08% With over 50% in Germany and France alone, and almost 19% in Spain, it is readily apparent that large manufacturers and well-known exporters are prevalent in the ETF. We will examine these holdings shortly. It is interesting, but not unexpected that there is little or no exposure to Eastern Europe or to extremely fragile economies such as Greece or Portugal. It is obvious that there is a dearth of companies in those countries that would qualify for the index and the ETF. In any event, it is euro denominated and hedged to mitigate exposure of a weakening euro/strengthening dollar. In terms of the sector exposure, we found it as expected, but informative. For information purposes here is the sector breakdown: HEDJ Sectors Sector Weight Consumer Staples 22.88% Industrials 18.42% Consumer Discretionary 17.89% Financials 12.13% Health Care 10.89% Telecommunication Services 5.84% Materials 5.59% Information Technology 4.82% Utilities 2.35% Energy 0.95% The sectors as noted, with over 71% in the top four indicates a strong consumer focus, along with industrials and financials. The luxury brands, European autos, and other consumer brands have maintained and grown significantly over the past five years thanks to the Asian and greater China region. Sales are expected to slow slightly, but remain strong into 2015. Financials will maintain their market share in spite of the numerous regulatory and legal issues over the past few years. Though not considered a diversified ETF, the remaining sectors are a welcome addition to the larger sector weights. In terms of the industry breakdown within the sector, we decided to analyze further the overall industry breakdown. For information purposes here is HEDJ’s industry breakdown: HEDJ Industry Exposure Industry Sector Weight Industry Sector Cont’d Weight Banks 9.66% Auto Components 1.23% Beverages 9.43% Health Care Providers & Services 0.95% Pharmaceuticals 9.35% Commercial Services & Suppliers 0.88% Automobiles 7.49% Construction Materials 0.82% Food Products 6.92% Energy Equipment & Services 0.62% Industrial Conglomerates 6.35% Household Products 0.55% Textiles,Apparel & Luxury Goods 6.20% Hotels, Restaurants & Leisure 0.52% Diversified Telecommunication Services 5.84% Health Care Equipment & Supplies 0.47% Chemicals 4.18% Metals & Mining 0.43% Machinery 3.57% Professional Services 0.41% Personal Products 3.19% Oil, Gas & Consumable Fuels 0.33% Food & Staples Retailing 2.79% Trading Companies & Distributors 0.24% Software 2.68% Containers & Packaging 0.16% Electrical Equipment 2.50% Leisure Products 0.14% Insurance 2.39% Gas Utilities 0.13% Aerospace & Defense 2.36% Biotechnology 0.12% Multi-Utilities 2.22% Household Durables 0.11% Media 2.20% Technology Hardware, Storage & Peripherals 0.11% Construction & Engineering 2.11% Electronic Equipment Instruments & Components 0.11% Semiconductors & Semiconductor Equipment 1.92% Thifts & Mortgage Finance 0.08% As noted above in our comments on sectors, the industry breakdown provides a clearer picture of the overall holdings. As we mentioned, in spite of the large broad base of industries here, this is not a diversified ETF. It does have a broad range of constituents in various industries that export products worldwide. The breakdown, unfortunately, would be considered too narrow in scope to be considered a “properly diversified” ETF. In any event, we do consider this “mix” of industries attractive for both institutional and retail investors. Before we review the all-important fees and returns, we analyzed the top 15 holdings. For information purposes here are the top 15 holdings, their underlying symbol, credit ratings and fund and index weight. Security Name Symbol Credit Ratings Fund/Index Weights Anheuser-Busch InBev NV BUD A2/A 6.67326%/6.68% Telefonica SA TEF Baa2/BBB 5.70949%/5.68% Banco Santander SA SAN Baa1/BBB+ 4.90776%/5.54% Banco Bilbao Vizcaya Argentaria SA BBVA Baa2/BBB 4.53209%/4.20% Unilever NV UN A1/A+ 4.50265%/4.57% Daimler AG OTCPK:DDAIY A3/A- 4.46096%/4.40% Sanofi-Aventis SA SNY A1/AA 4.25258%/4.33% Siemens AG OTCPK:SIEGY Aa3 /A+ 4.24605%/4.17% Bayer AG OTCPK:BAYRY A3/A- 3.46796%/3.49% L’Oreal SA OTCPK:LRLCY P1/A1+ 3.11318%/3.12% Bayerische Motoren Werke AG OTCPK:BAMXY A2/A+ 2.90227%/NA LVMH Moet Hennessy Louis Vuitton OTCPK:LVMUY NA/A+ 2.77273%/NA SAP AG SAP A2/A 2.29128%/NA E.ON SE OTCQX:EONGY A3/A- 2.17989%/NA Koninklijke Philips Electronic PHG A3/A- 1.97202%/NA The top 15 companies represent 57.984% of the ETF, while the remaining 111 constituents represent 42.015%. This is a very large concentration as compared to other ETFs we have analyzed. It is informative and indicates the large concentration of these major firms in the top 15. We are very comfortable with these major consumer and “household” names. With beverages, pharmaceutical, luxury brands, autos, cosmetics, etc., we have no issues whatsoever with this concentration. It is also indicative of the large institutional ownership of this ETF. We researched the credit ratings of the top 15 simply to verify what we surmised. That hypothesis was that the companies listed have strong balance sheets and have weathered the recession in Europe and the EU zone relatively unscathed thanks to their large export driven business model. It should be noted, that though the EU zone and Europe in general has sluggish growth (to put it mildly), there are consumers and businesses that are currently and continually purchasing, though at a significant reduced manner. One other note, the index components obviously don’t match exactly with the fund, represented in a current tracking error of .54%. We will touch upon the EU exposure, and a few opinions from others for 2015 shortly. Expenses, Returns and Recommendation Category HEDJ WTEHIP{Index} Expense Ratio .58% – Turnover Ratio (03/31/14) 28.00% – Distribution Yield Annual Dividend Yield 16.90% 2.17% 2.57% SEC 30 Day Yield 0.93{fund} 2.44%{Fidelity} – YTD Return(12/26/14)/(11/30/14) 2.89%/7.53% 3.12%/7.93% (estimates) 12 Month Return 3.81% 11.56% Share Beta/Holdings Beta .93/.60 .68 (compared to the MSCI EAFE index) With an inception date of December 31, 2009, the fund has an attractive track record since inception. Its expenses of .58% are near an industry average of .42%. WisdomTree states their returns as average annual since inception as well, which is 9.75% over the last year. We had a little difficulty in verifying the performance of the shares. After analyzing the numbers ourselves, we concurred with the figures provided by Morningstar and their analysis. In terms of the confusing dividend returns, as a quarterly dividend payer, the fund recently paid a distribution on December 26. This distribution included ordinary income and year-end short-term capital gains, along with long-term capital gains. This “bumped” the returns, hence the higher number reported by fidelity.com under the category of SEC 30-day yield. The distribution yield quoted by the fund takes into consideration the recent distribution paid by the fund. The difference in returns by the fund and the index are simply from the tracking errors, and overall structure of the fund and its slight hedging “haircut” that trims its returns. What is interesting to note is that net inflows over the past month have totaled over $1.37 billion, and short interest has declined 70.25%, which technically indicates a significant rally is pending. This is in spite of the ETF trading at a 1.01% premium to its NAV. What many institutional investors and economists are seeking is an ECB quantitative easing in 2015. Many have called for the ECB to move swiftly at their policy making meeting in January, especially with a deeper crises in Russia. With eurozone inflation running as low as 0.3%, there is concern of negative inflation persisting. We concur with noted columnists and economists who are calling for this easing. As such, HEDJ is poised for significant returns in 2015 as the large cap companies with strong balance sheets and established models will continue to flourish. Though we would not be surprised at the ECB waiting further before taking significant action, we do expect this ETF to outperform and continue to lead other hedged European ETFs. As such, we recommend a buy on this category leading ETF into 2015 and beyond. Additional disclosure: Data and additional information from wisdomtree.com, xtf.com,etfdb.com, morningstar.com, fidelity.com, moodys.com, standardandpoors.com, tdwaterhouse.ca, scmp.com, and our own analyis.
