In contrast, U.S. small caps that are in the Russell 2000 have a yield only half as high. S&P’s Young notes that the difference is due to a U.S. preference that balances dividend payments and share buybacks, whereas most European firms focus on dividends.
Despite the travails of the European economies, small caps have fared relatively better than their large-cap peers. The WisdomTree fund, for example, has outgunned large-cap ETFs such as Vanguard FTSE Europe ETF (VGK) on a one-year, three-year and five-year basis. The relative strength may also be due to the WisdomTree’s focus on income. The ETF’s portfolio is rebalanced quarterly to focus on the highest-yielding stocks that comprise the bottom quartile of liquid European stocks (in terms of market value).
Investors in search of lower expense ratios in a static (and non-rebalanced) portfolio should give that Vanguard fund a close look. It’s a top pick of S&P’s Young, due to a combination of growth and value. The value part of the equation has emerged after this fund has risen roughly 20 percent over the past two years, trailing the 45 percent gain for the S&P 500.
Young notes that the MSCI Europe index trades for roughly 12.5 times forward profits, fully two percentage points below the S&P 500’s multiple. He adds that European profits are expected to grow 13 percent over the next 12 months, which is “higher than the forecasts for the S&P 500, Canada, Japan or Emerging Markets,” he wrote in a recent note to clients.
Todd Rosenbluth, research director at S&P Capital IQ’s ETF, is a big fan of the SPDR EURO STOXX 50 (FEZ), citing its attractive group of top 10 holdings. “We think they sport very appealing valuations as a group compared to their U.S. rivals,” he says. Rosenbluth adds that portfolio companies such as Sanofi, Total and Bayer are strong global operators that tend to fare well in all economic climates.
As noted earlier, this fund has seen strong inflows in recent months. “The greatest interest is coming from the high-net-worth advisor community,” says State Street’s Mazza. “It’s been easy to explain the appeal of the fund’s base of global blue chip holdings.”
Fully two-thirds of the portfolio is invested in French and German companies, many of which would stand to benefit from rising economic activity across the Continent. Consensus forecasts anticipate 12 percent annualized profit growth over the next five years for this fund’s holdings.
Still, the Europe-wide exposure also explains why this fund has posted a negative 3 percent average annual return over the past five years. The weak performance means that the average price/book ratio in the fund is just 1.23, roughly half of the 2.48 price/book ratio of companies in the S&P 500. As an added bonus, the European blue chips offer solid dividend yields, leading this fund to generate a 3.2 percent payout (after expenses).
A key distinction between the Vanguard and SPDR ETFs mentioned in this article is that the former has considerable exposure outside the Eurozone––the U.K. and Switzerland are the first and third largest holdings, and together comprise nearly 48 percent of the fund’s portfolio (as of July 31). In contrast, the SPDR fund focuses only on Eurozone members. The SPDR’s 0.29 percent expense ratio is quite attractive, but can’t compete with the Vanguard fund’s rock-bottom 0.12 percent expense ratio.
After stunning investment gains here in the U.S., global investors are beginning to focus more heavily on Europe. Though the economic malaise has been in place for an unusually extended period, the seeds have been planted for economic renewal and economists are starting to take note of “green shoots.” That’s a phrase that was bandied around in the U.S. several years ago, and investors aim to harvest that theme in Europe in the quarters ahead.