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HEDJ Seeks To Provide EU Exposure While Hedged, Will It Continue To Outperform?

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.

Top ETF Stories Of 2014 Worth Watching In 2015

The stock market across the globe has given mixed performances in 2014. While the Dow Jones Industrial Average crossed the 18,000 mark for the first time in mid December and the S&P 500 is on the verge of crossing the 2,100 level on the back of an accelerating job market and improving economic fundamentals, a number of international economies have either slipped into recession or are struggling to reignite growth. In particular, several events will likely spill over into 2015 and continue to impact the ETF world either in a positive or a negative way. Below, we have highlighted some of these events, which will hog investor attention in the New Year: Oil/Energy ETFs The broad energy space hit headlines all year round as oil price jumped to a fresh high in mid June and then took a reverse turn slipping to a multi-year low in December. While geopolitical tensions in Russia and insurgency in Iraq propelled the oil prices and the energy ETFs higher in the first half of the year, rising U.S. shale oil production, abundant supply, slowing global demand, no cut in OPEC output, and a strong dollar pushed them to lower levels in recent months. Whether the bear will continue to chase the energy space or will it turn around in 2015? This is THE question everywhere in the world. However, oil price is showing some strength in today’s trading session on concerns over the Libyan supply disruption. As a result, investors should definitely keep a close eye on ETFs that will largely be impacted by this development. In particular, the First Trust ISE-Revere Natural Gas Index Fund (FCG ) , SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA: XOP ) , Market Vectors Oil Services ETF (NYSEARCA: OIH ) , United States Oil Fund (NYSEARCA: USO ) and United States Brent Oil Fund (NYSEARCA: BNO ) are some of the funds that could see huge volatility. FCG, having a Zacks ETF Rank of 5 or ‘Strong Sell’ rating, has stolen the show this year, plunging 41.2% while XOP and OIH lost about 28% and 24.2%, respectively and have a Zacks ETF Rank of 4 or ‘Sell’ rating. The future-based oil ETFs – BNO and USO – declined 47.8% and 41.7%, respectively. Russia ETFs Russian ETFs have seen horrendous trading this year thanks to several rounds of Western sanctions imposed on the country for invading Ukraine and the oil price collapse. The Russian ruble also saw a terrible decline against the greenback, losing about 50% since June. To combat the slide in the currency and reinvigorate growth, the Russian central bank has taken various measures. While direct currency intervention, minor rate hikes, and tightening supplies of the ruble did not bear any fruit, the central bank took a bold step this month by raising key interest rates rate from 10.5% to 17%, representing the steepest one-time hike in 16 years. The ruble has recovered slightly after the move but Russian economic growth still remains gloomy due to limited opportunities for investment, declining oil prices, rising inflation, weak deposit growth, soft earnings, falling consumer confidence and lack of growth drivers. Given this, Russia ETFs remained in investors’ eyes in the emerging/European market space in 2015. There are currently four non-leveraged ETFs targeting the Russian stocks – the Market Vectors Russia ETF (NYSEARCA: RSX ) , iShares MSCI Russia Capped ETF (NYSEARCA: ERUS ) , Market Vectors Russia Small-Cap ETF (NYSEARCA: RSXJ ) , and SPDR S&P Russia (NYSEARCA: RBL ) . All the products currently have a Zacks ETF Rank of 5 and are down in the range of 40-50% this year. U.S. Treasury ETFs While short-term Treasury ETFs have stayed almost flat this year, long-term products are leading the space. This trend is unlikely to continue next year as the Fed is on track to raise interest rates given a strengthening U.S. economy. Some market experts expect the first interest rate hike since 2006 sooner than expected in mid 2015, resulting in aggressive higher yields since 2009. According to the Wall Street message , 2015 would be disastrous for U.S. government bonds. In fact, the short end of the yield curve is rising faster than the long end and the spread between the 5-year and 30-year yields tightened to 109 bps from 220 bps at the start of the year, indicating that the yield curve is plateauing. As such, investors should take great precaution while trading in government bonds in the coming months. The three most popular Treasury funds – iShares 1-3 Year Treasury Bond ETF (NYSEARCA: SHY ) , iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) and iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) are up 0%, 6.20%, and 22.14%, respectively. All these products have a Zacks ETF Rank of 3 or ‘Hold’ rating. SHY targets short end of the yield curve while IEF and TLT focus on mid-term and long-term government bonds, respectively. Bottom Line Investors should closely watch the developments in these spaces as we head into the next year and should tap opportunities as and when they come.

Best And Worst Bond ETFs Of 2014

The U.S. stock markets delivered a somewhat muted performance this year (at least when compared to 2013) with the S&P returning about 12% YTD gains. The towering market of last year turned into a market that saw fears about a global slowdown and its effect on U.S. corporate earnings, plummeting oil prices, sluggish growth in Japan, concerns of a triple dip recession in Europe and the outbreak of the Ebola virus that forced many investors to look for safety and shun risky assets. Needless to say, the above threats kept bond yields at the lower side throughout the year causing investors to hunt for income bets. While long-term bond ETFs were weak last year due to taper threats, short-term bond ETFs hit the brakes this year due to rising rate concerns. Despite the Fed’s repeated assertion of keeping the rates low for longer, the recent strength in economic data has led to concerns that the Fed could start raising rates after the first quarter of 2015 instead of the initial June or September 2015 timelines. This in turn has lowered the appeal for short-term bond ETFs giving leeway for long-term bond ETFs to score higher in the face of dwindling global growth and an oil price rout. Flight from risk has caused the yield on the benchmark 10-year Treasury note to hover around 2%. Amid such a situation, it would be interesting to note which ETFs were the leaders and laggards in the bond space during 2014: Winners Two bond ETFs – the PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (NYSEARCA: ZROZ ) and the Vanguard Extended Duration Treasury ETF (NYSEARCA: EDV ) – soared this year having returned more-or-less 45%. ZROZ tracks the BofA Merrill Lynch Long U.S. Treasury Principal STRIPS index with effective maturity and effective duration of the fund being 28.99 years. On the other hand, EDV follows the Barclays U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index. The fund has average maturity of 25.3 years and average duration of 25.0 years. The next best performers in the space comes in the form of the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) , SPDR Barclays Capital Long Term Treasury ETF (NYSEARCA: TLO ) and iPath US Treasury Long Bond Bull Exchange Traded Note (NASDAQ: DLBL ) . These long-term bond ETFs have returned about 25% each this year. SPDR Nuveen Barclays Build America Bond ETF (NYSEARCA: BABS ) – a long-term muni bond ETF too returned smartly (up 21.6%) in 2014. To beat the potential rise in U.S. inflation and rack up gains on the real return, long-term TIPS bond ETF, the 15+ Year U.S. TIPS Index Fund ( LTPZ), was in demand in 2014 and has added about 19.3%. In short, the trend clearly indicates the inclination toward long-term bond ETFs. Beyond the border, PowerShares DB Italian Treasury Bond ETN (NYSEARCA: ITLY ) added about 19% this year thanks to the extremely easy monetary policy. Losers Thanks to the flattening of the yield curve, the U.S. Treasury Steepener ETN (NASDAQ: STPP ) turned out as an acute loser in this space. The product tracks the returns of a notional investment in a weighted “long” position in relation to 2-year Treasury futures contracts and a weighted “short” position in relation to 10-year Treasury futures contracts. Bullish stance on 2-year Treasury made the product a loser. The product was down 18%. Apart from this, junk bond ETFs like Peritus High Yield ETF (NYSEARCA: HYLD ) lost about 13% as returns were great in the safe government bonds space. Needless to say, short-term bond ETFs like the S&P/Citi 1-3 Yr Intl Treasury Bond ETF (NASDAQ: ISHG ) were defeated in the race. The fund is down 10% this year. The fate was similar for the WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (NASDAQ: AGND ) with a loss of about 8.5%. Road Ahead Having presented the scorecard of the year, we would like to note that the trend will be quite similar in the year ahead. However, like 2014, TIPS ETFs should be out of the betting list courtesy of a tepid inflationary outlook across the globe. Apart from the long-term government bonds, investors having a stomach for risk can also have a look at the long-term investment grade corporate bond ETFs to earn some regular income along with securing the portfolio. To do so, investors might tap the Long-Term Corporate Bond Index Fund (NASDAQ: VCLT ) , SPDR Barclays Capital Long Term Corporate Bond ETF (NYSEARCA: LWC ) and iShares 10+ Year Credit Bond ETF (NYSEARCA: CLY ) .