Update: Lyxor UCITS ETF MSCI Europe

The MSCI Europe index is well-balanced in terms of country and sector exposure, and we believe that the fund has the potential to deliver above-average returns against the broader set of investment vehicles in the category over the long term. It ranks in the category’s first quartile over the trailing 3 years and in the second quartile over the trailing 5 and 10-year periods in risk-adjusted terms. 

With an expense ratio of 0.28%, the fund is competitively priced against the category, but average compared with rival ETFs tracking MSCI Europe. As measured by its tracking difference (fund return less index return, this optimised fund has shown above-average performance over the past three years in comparison with ETF peers. 

Fundamentale Analyse

Investors in European equities have a lot to thank the European Central Bank for since the 2011-12 sovereign debt crisis which threatened to break up the Monetary Union. ECB president Mario Draghi’s famous pledge in 2012 to “do whatever it takes” to preserve the euro, followed by the bank’s massive quantitative easing programme in 2015, has helped restore investor confidence in the region and support equity valuations. The ECB has since extended its bond purchases into 2017, driven its key interest rate down to zero and the deposit rate to negative terrain in order to encourage bank lending to economic agents. Monetary policy should only be expected to retain an ultra-loose stance for the foreseeable future, with the ECB ready to ramp up the stimulus to address downside risks to the outlook. 

The recovery in Europe from the 2008 financial crisis has been slower than in other parts of the world, most notably the US. And this has been amply reflected in the performance of the stock market, with the MSCI Europe (in local currency) returning 4.9%, compared to 9.9% for the S&P 500 in annualised total return terms for the period ending February 2016. 

That said, it would be a mistake to view Europe as a uniform market given the differences in the region’s economies. For example, the UK has experienced an astonishing recovery, while growth in the Euro area has been weak. The outlook in the euro zone economy is slowly improving thanks partly to the reforms adopted by several countries, including Spain, Italy and France. Results remain uneven though, and further structural reform is still essential. 

Just as it would be a mistake to view all European countries as identical to each other, it would be a mistake to believe that all blue chips are the same in all parts of the continent and driven by the same economic fundamentals. For example, UK and Spanish mega caps are dominated by global banking groups that still derive a significant part of their revenues from their domestic markets. In contrast, Swiss mega-caps, e.g. healthcare and consumer goods heavyweights, are all large, globally-exposed companies with relatively less Swiss and EU-derived revenues. Also, some of UK’s largest companies are resources companies whose performance is often directly linked to international commodity prices. Prices in the commodity market have been largely driven in recent years by demand from emerging markets, especially China.

Indexkonstruktion

The MSCI Europe Index includes approximately 85% of the equity market capitalisation of 15 countries across developed Europe. As we write, the index is comprised of approximately 450 stocks. Components must meet minimum criteria for liquidity, as well as foreign ownership restrictions. The securities are weighted by free-float market capitalisation. The index is reviewed and rebalanced quarterly. Financial services and consumer defensive are the index’s biggest sectors, with a 15-20% weighting each, followed by health care (13-15%) and industrials (10-12%). The Eurozone accounts for approximately half of the index value, followed by the UK (30-35%), Switzerland (13-15%) and the Nordics (8-10%). Within the Eurozone exposure, Germany and France have the biggest weights, accounting for 13-15% of the index value each.

Fondskonstruktion

Lyxor uses synthetic replication to track the performance of the MSCI Europe Total Net Return Index. The fund attempts to achieve that by holding a basket of securities and entering an unfunded swap agreement with parent company Societe Generale. The counterparty the gives away the daily desired return in exchange for the performance of the fund’s holdings. The fund’s holdings consist of highly liquid equities from OECD countries, the large majority of which are European. According to UCITS III regulation, counterparty risk exposure is limited to 10% of the fund’s NAV at the end of any given day. However, Lyxor has a daily target of zero swap counterparty exposure. Swaps are reset whenever their value becomes positive. They may sometimes have a negative value (between -2% and 0%), which would mean in this case that the fund owes the counterparty money. Lyxor does not engage in securities lending within the fund, which helps to minimise overall counterparty risk.

Gebühren

With a total expense ratio of 0.28%, the iShares ETF is in the middle of the range of ETFs tracking the MSCI Europe Index. Index funds should provide the returns of their benchmark, less fees. However, during the past three years, this fund had delivered more than that as its tracking difference (fund return less index return) has ranged from positive 0.06% to positive 0.22%.This can be attributed to the fact that the equity swap can generate efficiencies such as tax optimisation, lower holdings costs (custody/foreign exchange) and enhanced corporate actions management. Investors should also consider trading costs, including bid-ask spreads and brokerage fees, when buying and selling the ETF.

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Alternativen

There is no shortage of ETFs offering exposure to European equities.

Among those tracking the MSCI Europe Index, the largest ones, in terms of AUM, are the db x-trackers MSCI Europe (DR) 1C (TER: 0.30%) and iShares MSCI Europe (Acc) (TER: 0.33%).

The fees for plain vanilla market cap-weighted Europe ETFs range from 0.12% to 0.51% and the cheapest one is the Vanguard FTSE Developed Europe ETF.

Investors are also offered a number of ETFs tracking the STOXX Europe 600 Index at TERs ranging between 0.18% and 0.30%. With a fixed number of 600 constituents, the STOXX Europe 600 has a similar make-up to the MSCI Europe Index, except that it has a slightly higher tilt towards mid-cap companies. The largest ETFs in this group are the iShares STOXX Europe 600 (DE) (TER: 0.20%), and db x-trackers STOXX Eurp600 (DR) 1C (TER: 0.20%).

Finally, there is growing number of strategic beta products, which seek to either improve the performance or alter the risk of traditional market cap-weighted index products. Popular ETFs, in AUM terms, include Ossiam iSTOXX EurMiniVar (TER: 0.65%), Source Goldman Sachs Equity Factor Europe (TER: 0.55%) and iShares MSCI Europe Minimum Volatility (TER: 0.25%). Other strategies include value, growth, quality and size. It is important to understand that all of these strategies can experience long periods of underperformance relative to the broad market.