HEDJ - Wisdom Tree Focused Euro Area Hedged ADR

[twacowfca]

HEDJ ADR  is now our second largest holding. It holds a focused portfolio of Euro area large caps that meet Wisdom Tree's value criteria, including receiving the majority of income from exports or sales outside Euroland. That generally means dollar sales with the dollar stronger than the Euro and likely to stay that way with the prospect of QE in Euroland and possibly tightening in USA . This fund selects high dividend payers.

 

Wisdom Tree has refocused the holdings of HEDJ recently. These companies read like Warren's wish list, although there are a  few that may not meet his cut. In fact, Warren has and does own some of these companies. Wisdom Tree refocused the portfolio  to emulate the huge home run they hit in 2013 - 2014 with their hedged ETF Japan fund ADR after QE there.

 

We prefer to buy individual equities ratrlher than funds, but that preference is overridden by the advantage of letting the fund manager maintain the hedge of the EURO against the USDollar. That is the main appeal of owning HEDJ. Another big plus is that it is a low management fee, highly liquid ETF. 

 

With the hedge, we'll get the upside from the likely dramatic appreciation of Euro stock prices following the large QE program set to begin next month, without losing a lot of those gains to the likely continued weakness of the EURO /USD.

 

The fund is already up @ 8% from our entry last month just before the ECB made their big QE announcement. :)

 

 

 

 

[giofranchi]

The fund is already up @ 8% from our entry last month just before the ECB made their big QE announcement. :)

 

Congratulations, twacowfca!

 

And thank you for another good idea! :)

 

Cheers,

 

Gio

[CorpRaider]

I've been considering this over the past several months (really since the launch).  I haven't yet been able to convince myself that the odds that I am seeing this geopolitical/macro trend better and/or earlier than others are decent.  It will probably be a great success. 

 

 

[twacowfca]

I've been considering this over the past several months (really since the launch).  I haven't yet been able to convince myself that the odds that I am seeing this geopolitical/macro trend better and/or earlier than others are decent.  It will probably be a great success.

 

Stock markets have gone up a lot after central banks have announced large QE programs. Those gains continue through the end of those programs. There was QE 1 in the US with a large gain, followed by a pull back and pause before QE 2 began.  Then, there was QE 2, Operation Twist and QE3, all leading to large gains in the stock market.  The same dynamic led to large gains in Japan with their massive QE program, beginning in 2013.

 

QE programs typically lead to depreciation of the currency, although that hasn't happened with the US with the USD being the reserve currency and the US ending its QE programs as other countries continue to ramp up their QE programs . 

 

The stock market and economy in Great Britain was less affected by the Great Depression than the US because they devalued by going off the gold standard sooner than the US did. Similar devaluations ( Rather like QE ) led to similar reactions in other European countries.

 

This is logical. Increasing the number of currency units available for measuring economic output and stock market values should eventually produce higher nominal values for equities.  The ability to hedge prospective gains to capture them without losing part of the gains through currency depreciation is appealing.

[Sullivcd]

Twacowfca, thank you for sharing your idea.  Given the history of other ideas you have shared with the board, it would probably be in my best interest not to question and put in a sizeable order.  However, the stat sheet of HEDJ reveals a PE of 17.87 and a PB of 2.06, not exactly cheap.  How do you think about the downside with these valuation levels? 

[twacowfca]

Twacowfca, thank you for sharing your idea.  Given the history of other ideas you have shared with the board, it would probably be in my best interest not to question and put in a sizeable order.  However, the stat sheet of HEDJ reveals a PE of 17.87 and a PB of 2.06, not exactly cheap.  How do you think about the downside with these valuation levels?

 

Values are OK to good prospectively.  Massive QE typically gooses profits as stock market prices also rise.  The companies in the fund will see their competitive position improve relative to the USD, especially as they have most of their sales outside the Euro area. that 's a double whammy for them.

These animals are better than the average critter; they pay large dividends, indicating that a relatively high proportion of their profits are owners earnings .

[Chalk bag]

Agreed. The setup is perfect for a European recovery (and shame on them if they blow it): low oil price lowers cost, cheap currency really helps export, QE lowers the cost of funding to ridiculous levels, and the sentiment could not be more negative due to all the reasons we already know.

[twacowfca]

HEDJ continues to rise even before QE starts this month.  The potential seems to be similar to gains the US Equity market experienced from January 2013 to now.

 

Is this idea in the "too easy" pile for many on the board  ???

[Sullivcd]

Fortunately your logic was simple enough for my small brain to understand and I made it a half-sized position.  I owe you quite a few beers already!

[Guest Schwab711]

I'll provide a less concise and more opinionated anti-thesis :)

 

twacowfca:

I like the idea but a lot of Euro stock indexes are up 10%+ this year alone. Given all the problems that have yet to play out, I think it's risky to buy near the top. Also, I don't think it's a given that QE policy in Europe will play out like QE in the US (or Japan). I think the US markets have experienced gains because or growth in underlying businesses. Europe has high valuations and QE doesn't seem large enough (or necessary) at 1/8th the size of US QE given their systemic problems. I've looked at a lot of large-cap Euro companies with foreign revenue but valuations are similar to the US markets yet the European economy is in considerably worse shape. I think you did a great job of pointing this out, but a significant part of the returns for HEDJ will revolve around the FX rate of USD/EUR (currently $1.12). The hedges mean you you have to be right on direction and velocity, which small investors may not be able to fully grasp (I couldn't figure out what their "hedges" are from their filings). You must think we are moving towards $1 over the next few years? Again, this is a purchase at the top as EUR/USD rates have historically been closer to $1.5. I do believe in the validity of the strengthening of the USD over the past few years but there's no doubt the move has been dramatic and there is a significant incentive for the US to prevent it from appreciating too far. I prefer US multi-nationals at the moment.

 

 

Why I like it:

- Euro region is likely near a relative trough for macro

- These equities have lower valuations than similar US counterparts (with similar foreign rev %)

- FX rate has depreciated significantly

- These are excellent multi-national companies who benefit from continued depreciation

    * As a side note, how are multi-nationals in both US and Euro-region experiencing FX losses (USD appreciates; EUR declines)? Obviously incorrect hedges but I think its informative such that correctly predicting currency movements will not guarantee returns when you invest in derivative ideas (equities as opposed to a straight FX position).

 

Why I'm not interested:

- Expense Ratio is 0.5% higher than non-hedged Euro ETF

- Diversified to European region (I don't want total exposure to such a structurally terrible economy)

- Euro equity valuations in general are too high for the near-term risk they face

- I think you are paying a premium for QE before the benefits are seen

- I don't see QE working half as well for Euro region as it did for the US. Rates were already low in the Euro region, why do they need this increased liquidity?

- They trade with China at a greater rate than US multi-nationals and I don't like the future prospects of China

- There are real incentives for other nations not to allow the EUR to depreciate too far vs. their currencies

- The USD/EUR hedge works as leverage for this investment (do you want to invest in the underlying companies or speculate on FX rates?)

- I don't think a lower EUR is necessarily beneficial for the region as credit becomes increasingly more expensive when QE is trying to do the opposite

- All ETFs have a premium/discount to NAV that is partially based on demand for the strategy and partially due to liquidity. This ETF has seen AUM increase from $1b to $10B in just 10 months! $4.35B in inflows in 2015 alone! This has the feel of a fad and it makes me weary. It's already close to the largest Euro-based ETF available. Why isn't a simple index the largest? Just another reason I think the demand for this strategy is relatively too high. Finally, you are not the only one who sees this strategy as easy. IIs have already positioned themselves in similar ways since QE appears to have worked so well for US and Japan. Strategies based on excellent returns for similar situations tend not to work as well as the base-cases.

 

 

http://finance.yahoo.com/news/euro-hedged-etf-tops-10b-173053963.html

http://jeremylhill.tumblr.com/post/112250831418/a-little-too-bullish-on-europe

[twacowfca]

I'll provide a less concise and more opinionated anti-thesis :)

 

twacowfca:

I like the idea but a lot of Euro stock indexes are up 10%+ this year alone. Given all the problems that have yet to play out, I think it's risky to buy near the top. Also, I don't think it's a given that QE policy in Europe will play out like QE in the US (or Japan). I think the US markets have experienced gains because or growth in underlying businesses. Europe has high valuations and QE doesn't seem large enough (or necessary) at 1/8th the size of US QE given their systemic problems. I've looked at a lot of large-cap Euro companies with foreign revenue but valuations are similar to the US markets yet the European economy is in considerably worse shape. I think you did a great job of pointing this out, but a significant part of the returns for HEDJ will revolve around the FX rate of USD/EUR (currently $1.12). The hedges mean you you have to be right on direction and velocity, which small investors may not be able to fully grasp (I couldn't figure out what their "hedges" are from their filings). You must think we are moving towards $1 over the next few years? Again, this is a purchase at the top as EUR/USD rates have historically been closer to $1.5. I do believe in the validity of the strengthening of the USD over the past few years but there's no doubt the move has been dramatic and there is a significant incentive for the US to prevent it from appreciating too far. I prefer US multi-nationals at the moment.

 

 

Why I like it:

- Euro region is likely near a relative trough for macro

- These equities have lower valuations than similar US counterparts (with similar foreign rev %)

- FX rate has depreciated significantly

- These are excellent multi-national companies who benefit from continued depreciation

    * As a side note, how are multi-nationals in both US and Euro-region experiencing FX losses (USD appreciates; EUR declines)? Obviously incorrect hedges but I think its informative such that correctly predicting currency movements will not guarantee returns when you invest in derivative ideas (equities as opposed to a straight FX position).

 

Why I'm not interested:

- Expense Ratio is 0.5% higher than non-hedged Euro ETF

- Diversified to European region (I don't want total exposure to such a structurally terrible economy)

- Euro equity valuations in general are too high for the near-term risk they face

- I think you are paying a premium for QE before the benefits are seen

- I don't see QE working half as well for Euro region as it did for the US. Rates were already low in the Euro region, why do they need this increased liquidity?

- They trade with China at a greater rate than US multi-nationals and I don't like the future prospects of China

- There are real incentives for other nations not to allow the EUR to depreciate too far vs. their currencies

- The USD/EUR hedge works as leverage for this investment (do you want to invest in the underlying companies or speculate on FX rates?)

- I don't think a lower EUR is necessarily beneficial for the region as credit becomes increasingly more expensive when QE is trying to do the opposite

- All ETFs have a premium/discount to NAV that is partially based on demand for the strategy and partially due to liquidity. This ETF has seen AUM increase from $1b to $10B in just 10 months! $4.35B in inflows in 2015 alone! This has the feel of a fad and it makes me weary. It's already close to the largest Euro-based ETF available. Why isn't a simple index the largest? Just another reason I think the demand for this strategy is relatively too high. Finally, you are not the only one who sees this strategy as easy. IIs have already positioned themselves in similar ways since QE appears to have worked so well for US and Japan. Strategies based on excellent returns for similar situations tend not to work as well as the base-cases.

 

 

http://finance.yahoo.com/news/euro-hedged-etf-tops-10b-173053963.html

http://jeremylhill.tumblr.com/post/112250831418/a-little-too-bullish-on-europe

 

WOW. Thanks, Schwab711.  That's a great list to help take the confirmation bias out of my sails. Let me chew on it for a while.

 

What jumped out of the list first was the possibly wrong supposition that the USD/Euro would stay strong or go up.  How's the PPI now between USD and Euro?

[tytthus]

this is sorta related to HEDJ....the share of European companies with dividend yields greater than corporate bond yields is sitting at around 70%, compared to an average of 18% since 1999.  it's a fairly shocking graph...

 

i realize  this is mostly because of how far bond yields have fallen (some even negative!), but still... it's be nice to see a longer history of this too. (anyone know if a longer time frame of this is available?)

 

found this in 361 capital's always excellent weekly briefing:

http://www.361capital.com/weekly-briefings/find-bonus-points/?mkt_tok=3RkMMJWWfF9wsRoku67PZKXonjH

pfsX56usqXqW%2FlMI%2F0ER3fOvrPUfGjI4CT8VkI%2BSLDwEYGJlv6SgFSrnEMbd1zbgOWBE%3D

 

if yields and corporate bonds remain at this level, i gotta think European equities are still a good buy.

[twacowfca]

this is sorta related to HEDJ....the share of European companies with dividend yields greater than corporate bond yields is sitting at around 70%, compared to an average of 18% since 1999.  it's a fairly shocking graph...

 

i realize  this is mostly because of how far bond yields have fallen (some even negative!), but still... it's be nice to see a longer history of this too. (anyone know if a longer time frame of this is available?)

 

found this in 361 capital's always excellent weekly briefing:

http://www.361capital.com/weekly-briefings/find-bonus-points/?mkt_tok=3RkMMJWWfF9wsRoku67PZKXonjH

pfsX56usqXqW%2FlMI%2F0ER3fOvrPUfGjI4CT8VkI%2BSLDwEYGJlv6SgFSrnEMbd1zbgOWBE%3D

 

if yields and corporate bonds remain at this level, i gotta think European equities are still a good buy.

 

With HEDJ up about 15% from our massive purchase eight weeks ago, confirmation bias is oozing from my pores.  Could this be a double before that extreme spike on the graph normalizes?

 

Meanwhile, will US equities merely be volatile as Yellen predicts?

[Jurgis]

 

With HEDJ up about 15% from our massive purchase eight weeks ago

 

Congrats twacowfca! Great thesis and great purchase.

[Charlie]

I have been thinking about buying the DAX index (the broad german index), because of european quantitative easing and the earnings upside of german export companies, because of the low Euro and because of Buffetts comments about German companies.

 

I did nothing, because I don´t like to buy at all time highs and there are also a lot of not so wonderful companies in the DAX index.  :(

 

 

https://www.comdirect.de/inf/indizes/detail/chart.html?timeSpan=1D&ID_NOTATION=20735#timeSpan=3M&e&

[twacowfca]

I have been thinking about buying the DAX index (the broad german index), because of european quantitative easing and the earnings upside of german export companies, because of the low Euro and because of Buffetts comments about German companies.

 

I did nothing, because I don´t like to buy at all time highs and there are also a lot of not so wonderful companies in the DAX index.  :(

 

 

https://www.comdirect.de/inf/indizes/detail/chart.html?timeSpan=1D&ID_NOTATION=20735#timeSpan=3M&e&

 

If the Euro depreciates 10% or so below parity with US Dollar, we may buy selected European equities, instead of adding to HEDJ. Robert Shiller says he's buying Italian and Spanish equities as bargains for his personal equity portfolio that used to be entirely US stocks.

 

Gio,

 

You have said that you were not keen on Italian or Spanish stocks, but those countries are finally getting their finances in better order, according to Shiller. Any ideas?

[Charlie]

Munger said some funny things about investing in Italy and Greece at the Berkshire Hathaway annual meeting 2013.

 

Be careful there.  ;)

 

 

[ccap]

I think this is a very interesting idea.  I've been considering variations on it for a while but have been unable to pull the trigger.  My concerns are:

1) I think I can do better than an index.  Every time I dig in and look at the individual businesses, they rarely seem as cheap as I hope.

2) I have concerns about how Europe does business.  Three businesses I own have European divisions.  These guys have constant litigation problems from labor.  One has an unresolved labor case from trying to lay off employees >15 years ago.  Between equity-holders, debt-holders, government, and labor, equity holders seem to have the lowest claim to the company.  Every time I see this, I'm reminded of why Munger prefers investing in the US.

 

Having said all of that, one of my holdings is a European business with most of its earnings in EUR.  I entered this position about a month ago.  I've gone back and forth on hedging the currency risk or not.  Eventually, I decided that I'd rather run the position unhedged.

 

John Hussman had a recent article with some interesting currency plots (http://www.hussmanfunds.com/wmc/wmc150316.htm).  The USD/EUR plot was interesting.  Assuming you believe that plot, you could make a mean reversion argument that you want to be long EUR, if your holding period is a few years.

 

Alternatively, the data in "Triumph of the Optimists" indicates that exchange rates corrected for inflation are very stable over long periods.  This is an interesting book, if you've never read it.