FEZ: Solid European Offering, Vulnerable To ECB Movements

The SPDR Euro Stoxx 50 ETF (NYSEARCA:FEZ) tracks the performance of the Euro Stoxx 50 index, which comprises 50 of the largest and most liquid European Stoxx across 11 Eurozone countries. As of writing, the fund has roughly $3.8B in assets. It has performed well on a trailing one-year basis, delivering ~17% return in the period. FEZ provides investors broad-based exposure to European blue-chip companies, but the persistent, unsteady macro-backdrop for Europe gives me pause. I rate FEZ as a hold for now.

Sector diversified fund, with a strong tilt towards France

FEZ is a relatively diversified fund. Large allocations go to industrials, tech, consumer cyclicals, and financials, however there is not one single sector that wholly dominates. I see this breakdown of sector allocation as a nice combination of both defensive and growth-oriented sectors.

Much like the sector allocation, individual holdings are well diversified across the fund. About ~44% of all assets are within the top 10 holdings. The fund’s largest allocation goes to ASML Holdings (ASML) at ~9%. ASML is a Dutch tech giant that specializes in the semiconductor supply chain. ASML has had a banner year, returning +37% on a trailing one-year basis, as global investment in the world of AI accelerates and demand for semiconductor technology rises. The fund’s second-largest holding at ~7% goes to global luxury giant Louis Vuitton (OTCPK:LVMHF), which has suffered on the back of weakening demand from Luxury consumers outside the Eurozone like China. LVMH is down ~9% on a trailing one-year basis.

Given this is a regional index, I wanted to take a look at the country level allocation to see how well the fund is diversified across the Eurozone. The fund has a strong allocation towards France, over 40%, with another quarter to Germany, and ~15% to the Netherlands. The fund is not particularly well-diversified across the Eurozone, but rather concentrated in industrial economies that have some strong similarities among them.

Encouraging flow pattern and decent diversification

FEZ has seen strong net inflows in the last 2 years, in particular in the first four months of 2024. These flows demonstrate investor conviction that a European recovery is likely on the horizon, and even with lackluster growth, an allocation toward European Blue Chips is a solid option for developed markets. FEZ remains reasonably well-priced. Its current book value is trading at 2x, while earnings are priced at around 14x. Again, when compared with SPY which is trading around 4.5 P/B and forward earnings of 22x, FEZ is a bargain.

When looking at 5 year monthly correlations, we see that FEZ vs. SPY offers reasonable diversification from US markets, while still offering decent return. FEZ has delivered annualized returns of 9.5% vs. SPY’s 13.8% return, with a .86 correlation. I see FEZ as a nice compliment to a core portfolio that is already allocated to SPY.

Performance of constituent countries

Given FEZ provides a regional representation of the Eurozone, I think it is worth looking at the recent performance of some constituent countries to help understand how they might compare to the performance pattern of FEZ. Please note, that these are not 1:1 comparisons, as the overlap of the makeup of the individual country ETFs does not map perfectly to FEZ, but it does give a loose idea of what countries are acting as return drivers within FEZ. As we can see from the chart below, EWN, a single-country Netherlands ETF has outperformed FEZ, from a total return perspective over the last year. France, the largest representation in FEZ, has delivered ~14% compared with FEZ’S ~21%.

From a volatility perspective, EWN has the highest 30-day rolling volatility, which, given its return profile, is not unexpected. Overall, FEZ’s volatility profile is middle of the road compared to the single country ETFs, which is what I might expect.

ECB rate movements pose near-term risks

The main risk for FEZ is how much of the market has already priced in an ECB rate cut in June and whether future rate cuts will soon follow. The ECB has indicated that, in all likelihood, a rate cut will occur in June. Inflation has slowed to the lowest levels in years in France, while holding steady in Germany, the two largest economies in the EU. While this could be a boon for exporters in the fund, it could pose a challenge for the domestic economies, which would have to import on a weakening Euro vs. the dollar. It remains to be seen if the Fed will push forward with a rate reduction in June, but the FOMC has signaled that likely not. Eurozone countries with a weaker Euro and stickier-than-expected inflation could weaken domestic demand for some of FEZ’s constituents and pose a risk for the fund.

Conclusion

FEZ has strong components, with a solid return profile over the last 5 years. It has exposure to critical European companies. The fund is vulnerable to the machinations of the ECB, and because the EU is a monetary union (not a fiscal one), rate cuts in areas where inflation is still sticky could negatively affect the fund. This summer, all eyes will be on France, where the Olympics will take place. This could draw renewed attention to French brands, and will have a large impact on tourism, which is central to the French economy. I see this as a positive for FEZ. I am going to take a wait-and-see approach with FEZ because while I think the bones of this fund are quality, there could be a better time to buy.