Luxenberg: A Surge of Cash Into European Funds

NEW YORK (TheStreet) -- After struggling for years, European stocks are beginning to recover. This year iShares Europe (IEV) rose 19.5%. Investors have taken notice. Vanguard FTSE Europe ETF (VGK) attracted inflows of $6 billion in 2013, a large sum for an ETF with $12.4 billion in assets. A total of $3.7 billion flowed into iShares MSCI EMU (EZU), which has $6.6 billion in assets.

Positive news triggered the rally. The eurozone's GDP grew 0.3% in the second quarter of 2013, an indication that the protracted recession had ended. Now the European Union projects that GDP will grow 1.1% in 2014. While the recovery remains fragile, there is good reason to think that the rebound can continue, says Shep Perkins, portfolio manager of Putnam Global Equity ( PEQUX), a mutual fund. In Spain and some other countries, the unemployment rate has begun to fall. "The unemployment problem is still horrendous, but consumer confidence is starting to recover from a low level," he says.

Perkins says that European corporate profits are still 40% below the peak reached in 2007. But he says that earnings will make up the lost ground because managements have been jolted into restructuring. Before the crisis, many boards of directors tolerated inefficiencies and high labor costs. Faced with financial turmoil, companies have been streamlining operations. Perkins cites the example of Deutsche Post DHL, a German giant that delivers mail and packages. At the height of the euro crisis, the company brought in new management that cut costs and focused on strong businesses. Profit margins increased and the stock climbed. The company should continue improving, Perkins says. "Now that the economy is stabilizing there will be more benefits from restructuring," he says.

With stocks climbing, iShares MSCI EMU has ranked among the top performers, returning 31.8% in the past year. During the same time, Vanguard FTSE Europe returned 26.9%. But most investors who want to bet on the rebound of Europe should stick with the Vanguard fund, says Dennis Hudachek, an ETF analyst for IndexUniverse.com. Vanguard provides comprehensive coverage of all developed European countries, he says. The iShares fund focuses on countries that use the euro. "If you stick to the eurozone, you exclude the United Kingdom, Switzerland, and Sweden -- and those countries account for about half the total market capitalization of Europe," Hudachek says.

During the past year, the iShares eurozone fund excelled because it gives greater weight to such troubled countries as Ireland and Spain. Those rebounded sharply from depressed levels. The more stable countries -- such as the UK -- suffered smaller declines during the crisis and recorded weaker rallies lately. During the past year, iShares MSCI Ireland ( EIRL) returned 52.7%, while iShares MSCI United Kingdom ( EWU) returned 18.9%.

Besides covering all of the developed European markets, Vanguard FTSE Europe offers a low expense ratio of 0.12%. The iShares MSCI expense ratio is 0.53%.

Part of what boosted European funds recently was the rebound of the euro, which has gained 4% against the dollar this year. When a foreign currency strengthens, the value of overseas investments climbs for U.S. investors. While the euro helped fund returns this year, there is no guarantee that the currency will not slide and harm U.S. investors in the future. For protection against potential losses, WisdomTree has introduced a series of European funds that hedge away the currency risk. WisdomTree Europe Hedged Equity ( HEDJ) returned 17.5% this year, compared to a return of 21.5% for the unhedged iShares MSCI EMU. The gap can be explained by currency exposures. While the iShares fund received a boost from the euro strengthening, WisdomTree felt no effect at all.

It is hard to know whether the euro will continue strengthening. But there is a clear case for owning the hedged fund. Over the long term, currency gains and losses tend to balance out. By avoiding the currency swings, the hedged fund could be less volatile.

At the time of publication the author held no positions in any of the stocks mentioned.

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

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.

More from ETFs

3 Great Stock Market Sectors Millennials Should Invest In

3 Great Stock Market Sectors Millennials Should Invest In

Why Millennials Are Ditching Stocks for ETFs

Why Millennials Are Ditching Stocks for ETFs

60 Seconds: What's the Difference Between an ETF and a Mutual Fund?

60 Seconds: What's the Difference Between an ETF and a Mutual Fund?

Video: Why Shark Tank Star Kevin O'Leary Is Doubling Down on Internet Stocks

Video: Why Shark Tank Star Kevin O'Leary Is Doubling Down on Internet Stocks

Simple Investing Strategies Stand the Test of Time

Simple Investing Strategies Stand the Test of Time