Focusing on Quality With Europe ETFs

Greece, a country with an estimated 2014 GDP that is less than half of Apple’s (NasdaqGS: AAPL) market value, is dominating the European investment thesis, but with the right exchange traded funds, investors can latch onto quality in the region while limiting exposure to further Greek drama.

On Thursday, the volatile Greek government submitted reform proposals to Eurozone officials in an effort to secure further bailout aid. Eurozone officials are expected to review the package this weekend, potentially setting Greek stocks up for more early-week volatility next week. Without a third bailout, Greece likely defaults on its obligations and departs from the Eurozone.

“Direct channels of contagion are not the main concern, given the somewhat encouraging scenario derived from the macroeconomic, policy and market signal perspectives. Indirect channels are the bigger risk. Greece could become the first country to exit the single currency, shaking the firmly-held conviction that membership in the currency union is permanent and irrevocable. Any change in that perception, even driven by a relatively small and economically struggling nation such as Greece, could shake the foundation and potentially pave the way for other nations to follow. Redenomination risk would become real, translating to higher risk premia (especially during recessions),” said Deutsche Asset & Wealth Management Head of ETF Strategy Dodd Kittsley in a new research note.

Fortunately for investors in diversified Europe ETFs, including the Deutsche X-trackers MSCI EMU Hedged Equity ETF (NYSEArca: DBEZ), Greece is rarely if ever a big part of the equation in terms of fund holdings.

The euro hedged DBEZ, which debuted in December, allocates over 59% of its weight to French and German stocks. Spain and Italy combine for another 20%, but DBEZ’s PIIGS exposure after Spain and Italy is scant. DBEZ tracks the MSCI EMU IMI U.S. Dollar Hedged Index. Looking ahead, some analysts also anticipate double-digit earnings growth this year as a weaker euro currency, decline in oil prices and lower funding costs help support a continued recovery. [Hedged Europe ETFs As A Strategic, Core Position]

“Of course, markets must find macroeconomic fundamentals and policy toolkits credible. With that in mind, we decided to look at the correlations between the ten-year yields of Greece, Ireland, Italy, Portugal and Spain (GIIPS) during two distinct periods. The first, from 2010 to the end of 2011, represents the ‘pre-Draghi’s commitment’ world. The second, encompassing the last two years, is the ‘whatever it takes’ world,” adds Kittsley. [Support for Europe ETFs]

Of course, investors can opt to trim Eurozone exposure while maintaining long Europe positions, at least until the Greek drama blows over if it ever does. Improving earnings amid a backdrop of quantitative easing and faltering currencies bolsters the outlook for ETFs such as the Deutsche X-Trackers MSCI Europe Hedged Equity ETF (NYSEArca: DBEU).

DBEU tilts toward Europe’s higher quality equity markets nearly 46% of its weight devoted to U.K. and Swiss equities. France and Germany combine for another 28.2% of DBEU’s weight and some Nordic fare factors into the DBEU equation, but overall, the ETF’s exposure to the Eurozone periphery is small.