Want to Invest in a European ETF? Hedge First

NEW YORK (ETF Expert) --Value-oriented thinkers have labored to persuade investors to invest in Europe for nearly three years.

Specifically, they've pushed forward the idea that miraculously low price-to-book ratios offer compelling bargains in European ETFs, in spite of the ongoing sovereign debt crisis and negligible economic growth.

However, deep-discount investing during financial crises is a recipe for failure.

For example, by 2007, Bill Miller built Legg Mason Value into the largest mutual fund on the planet. Unfortunately, the guru chose to pack his luggage with banks and insurers.

Miller stubbornly stood by his "call" throughout the collapse in 2008, pointing to exceptionally attractive valuations like low price-to-book ratios. In the end, shareholders watched in horror as minus 75% returns had evaporated their asset.

Mr. Bill? He retired in reasonable comfort a year later.

Granted, there are differences between the credit crunch of 2008 and Europe's sovereign debt mess. Yet, there are more similarities than many care to admit. We're still talking about major banks and insurers holding toxic debts (e..g, Greek two-year notes, Spanish bonds, etc.) that threaten the global financial system. Saving the European banks will require more and more "bailout euros," which is likely to erode the value of the currency in the near term.

For this reason, I haven't had any direct exposure to Europe for several years. There's not enough diversification reasoning in the financial planning pot to persuade me that unhedged European ETFs are sensible risk-reward investments at this time.

In contrast, Russ Koesterich, iShares' global chief investment strategist, is the latest individual to suggest adding some European flare. He is recommending iShares MSCI France ( EWQ). The reasons he cites include a price-to-book multiple of 1.14, a 31% discount to the MSCI World Index and a 15% discount to Germany.

If we were able to rely on fundamentals alone, I might share Koesterich's assessment. Yet, France is a major component of a deepening recession in the region and the political leadership abhors capitalism. Moreover, a euro that depreciates against the dollar hurts EWQ's chances, and I see little evidence that the euro will strengthen over the next six months.

Then there is the technical picture. When European Central Bank chief Mario Draghi proclaimed in July that he would do whatever it takes to save the euro, European assets like EWQ hit a series (July, August, September) of "higher lows." That is a bullish pattern for stocks. In contrast, shortly after Draghi announced the specifics of the ECB's plans in September, EWQ has been hitting a series (September, October, November) of "lower highs." That is a bearish pattern for stocks.

While I continue to hitch my cart to Asia Pacific ETFs for "foreign exposure," I recognize that some ETF investors still want access to great European companies like Unilever ( UL), Sanofi-Aventis ( SNY) and Moet Hennessy Louis Vitton ( LVMUY).

If you feel the urge, then I advise using a currency hedged vehicle like WisdomTree European Hedged Equity ( HEDJ).

This exchange-traded fund is hedged such that you can expect higher returns than a similar non-currency hedged investment like EWQ... assuming the value of the dollar is increasing relative to that of the euro. Right now this is precisely what is happening. HEDJ is roughly 1% off its 52-week highs whereas EWQ is closer to 5% off its peak.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Disclosure Statement: ETF Expert is a website that makes the world of ETFs easier to understand. Gary Gordon, Pacific Park Financial and/or its clients may hold positions in ETFs, mutual funds and investment assets mentioned. The commentary does not constitute individualized investment advice. The opinions offered are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationships. You may review additional ETF Expert at the site.

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