Canadian investors pouring money into European equity ETFs
The European Union has a GDP of US$20 trillion, according to the International Monetary Fund. The United Kingdom has another US$3.8 trillion, making Europe a considerable economic force.
Yet up until recently, there’s been scant enthusiasm among Canadians for Europe-specific ETFs. Currently there are only nine distinct offerings, not counting multiple versions of some funds. Their combined assets are about $3 billion.
More than half of that total is held in two BMO ETFs, of which the largest is the $975-million BMO MSCI Europe High Quality Hedged to CAD Index ETF.
While European ETFs offered by the Global X, iShares and Vanguard families have also reached critical mass, others have thus far failed to attract significant assets.
But recent strong returns have breathed new life into European ETFs. “European equities, once a global afterthought, have delivered their strongest relative outperformance versus U.S. markets in 25 years,” said Maddy Griffith, ETF strategist with CI Global Asset Management in Toronto.
“For portfolios that have leaned heavily on U.S. exposure, now is a great opportunity to rebalance toward a region with lower valuations and credible policy momentum,” Griffith said in a recent internal CI report.
Lower price-to-earnings ratios
As has been the norm historically, European equities as a group are cheaper than their U.S. counterparts in terms of price-to-earnings ratios. Currently, the discount is in the 30–35% range.
The steep discount is attributable to the U.S. having had much higher earnings growth than Europe. “But this could be changing,” said Chris Cullen, senior vice-president and head of ETFs with Toronto-based Brompton Funds Ltd. “We could be in a transition period.”
Among the positive trends for Europe is the monetary-policy shift in Germany, Europe’s largest economy, which has freed up capital to spend on defence, infrastructure and clean energy.
A lasting ceasefire agreement in Russia’s war on Ukraine, while by no means certain, would also give Europe a boost. “There’s been a massive sentiment within the European market that eventually the sanctions will come off Russia and things will start to flow back and forth again,” said Ahmed Farooq, senior vice-president and head of retail ETF distribution with Franklin Templeton Canada.
And while U.S. tariff threats remain, the direct hit to corporate earnings would be limited since many European companies maintain manufacturing operations in the U.S., said CI’s Griffith.
There’s also a push within the European Union to reduce its dependence on the U.S. by diversifying trading relationships, Farooq said. Symbolic of that sentiment is the appearance of Make Europe Great Again caps, a counterpoint to U.S. President Trump’s signature MAGA slogan.
Here at home, advisors are looking abroad, and clients are demanding that they do so, Farooq said. “You can’t really eliminate the U.S. exposure because it’s such a big part of (world markets), but you can start to look at other parts of the world. And the European market is a spot where advisors are trying to move some of the money in that direction.”
Vanguard’s Dewan cautions that relatively low valuations alone don’t justify investing in European equities. The counter-argument is that European stocks may be cheaper than U.S. stocks for a reason, in part because of geopolitical conflict with Russia and unresolved tariff issues.
However, the Vanguard Capital Markets Model currently calls for a modest overweight in Europe over a 10-year time horizon.
Dewan favours foreign diversification that is global in scope, and Europe is a big part of that. European exposure within a portfolio will lower volatility, and “it provides obviously a different mix of industries, companies as well as currencies.”
In Europe, market capitalizations are generally smaller than in the U.S., Dewan noted. “So you get that size diversification, and really the other diversification you do get in European equities is you have a stronger value sector.”
European champs
The two most broadly based European equity ETFs are the Vanguard FTSE Developed Europe All Cap Index ETF, along with the iShares MSCI Europe IMI Index ETF and its currency-hedged version. All three are market-cap-weighted index strategies that hold large-, mid- and small-cap stocks, and have 1,200 or more holdings.
The Invesco S&P Europe 350 Equal Weight Index ETF and Global X Europe 50 Index Corporate Class ETF are variations on the passive indexing theme, with the Global X product holding only large-cap stocks.
BMO’s MSCI Europe High Quality fund, the market leader, employs quantitative screens. It selects companies with high return on equity, stable earnings growth and low financial leverage.
Employing methodologies that emphasize dividend income are BMO Europe High Dividend Covered Call Hedged to CAD ETF, CI Europe Hedged Equity Index ETF and RBC Quant European Dividend Leaders ETF.
The only fully actively managed strategy is that of Brompton European Dividend Growth ETF, co-managed by Brompton chief investment officer Laura Lau and senior portfolio manager Michael Clare.
The managers hold a concentrated portfolio of about 30 dividend-paying large-cap stocks that they consider to have an established history or strong prospects of future dividend growth.
To generate additional income, they also write covered calls on some of the holdings. Through selective option writing, “there is the opportunity to create some incremental value on those holdings,” Cullen said.
Europe-only ETFs are only one way to get exposure to the continent and its population of more than 500 million. In December 2022, Franklin Templeton converted its former Europe ETF to a more broadly diversified international equity fund, a much more popular category.
By placing clients in such a fund, Farooq said, advisors can simplify asset allocation and not worry about missing out on opportunities in Asia and Australasia.