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By Ben Johnson, CFA | 02-23-2015 02:00 PM

This ETF Takes the Euro Out of European Dividend Payers

WisdomTree Europe Hedged Equity offers a high-quality portfolio of dividend-paying equities while hedging against currency risk.

Ben Johnson: Long Europe/short the euro has become a popular investment thesis in recent months. This reflects the fact that European equities are currently looking relatively cheap versus their U.S. counterparts. But it's also evidence of investors' desire to take the euro out of their European-equity exposure.

The WisdomTree Europe Hedged Equity ETF (HEDJ) has mushroomed in size over the past twelve months as investors have piled on to this trade. Our preference for this fund over its peers--iShares Currency Hedged MSCI EMU (HEZU) and Deutsche X-trackers MSCI EMU Hedged Equity (DBEZ)--really boils down to a matter of index methodology.

The index underlying the WisdomTree fund is a proprietary index--one that's based on dividend-paying companies that are domiciled in Europe and are traded in euros. In order to be included in the index, they have to have at least a $1 billion market capitalization and derive at least half of their sales from countries outside of Europe. 

The stocks are subsequently weighted based on their annual cash dividends paid, and then individual positions are capped at 5% of the portfolio. Sector weights are capped at a quarter of the portfolio, and country weights are also capped at a quarter of the portfolio so as to avoid any undue concentration risk. The result is a portfolio of high-quality firms that have a long track record of returning cash to shareholders.

We see evidence of this in the fund's moat metrics. Twenty-nine percent of HEDJ's portfolio was composed of wide-moat firms as of year-end 2014. This [compares with] up to about 14% of HEZU's portfolio being allocated to wide-moat firms and 13% for DBEZ.

It's worth noting that the fund's price tag is steeper than its peers and its portfolio skews further up the market-cap ladder, which means, at the moment, it looks a little bit richer on a relative basis from a valuation perspective. That said, a sensible methodology that yields as high-quality portfolio of dividend-paying equities makes HEDJ our pick for euro-hedged European-equity exposure.

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