ETF Ideas For Diverging Developed Market Central Banks

When it comes to central bank policy, particularly the Federal Reserve's, there is no such thing as a surge thing. However, gambling men and women would, at the moment, be likely to bet that the Fed is cruising toward an interest rate hike next month. Those gamblers would probably also bet that the European Central Bank (ECB) will go the other way, adding to its already substantial quantitative easing efforts.

Predictably, the dollar's rise at the hands of soaring Treasury yields could stoke more inflows to one the fastest-growing segments of the ETF market: Currency hedged funds. Widely documented is the fact that investors have poured so much cash into currency hedged ETFs this year that 2015's top two asset-gathering ETFs are currency hedged funds and issuers are rushing to bring more of these products to market.

With that in mind and with the Fed and the ECB likely moving in opposite directions for the foreseeable future, ETFs such as the iShares Currency Hedged MSCI Eurozone ETF HEZU take on increased allure.

“Meanwhile, European stocks continued to rally on hopes for more monetary stimulus, rather than signs of economic recovery. Investors got what they were looking for last week, with several ECB officials confirming the likelihood that the central bank will expand its quantitative easing (QE) program,” said BlackRock Global Chief Investment Strategist Russ Koesterich in a recent note.

Up 11.7 percent year-to-date, the $1.9 billion HEZU devotes over 60 percent of its weight to French and German stocks. Germany and France, in that order, are the Eurozone's two largest economies.

“A falling euro and an ECB likely to expand its monetary stimulus are both catalysts for European stocks. The one caveat: Given that further gains are partly predicated on a weaker currency, dollar-based investors should continue to consider currency-hedged vehicles,” adds Koesterich.

Investors looking for domestic ETFs poised to benefit from diverging developed market central bank policies ought to focus on large- and mega-cap funds, such as the $4.6 billion iShares S&P 100 ETF OEF. As its name implies, OEF is home to the 100 largest U.S. companies as ranked by market capitalization.

Technology and health care names combine for nearly 40 percent of OEF's weight and while many of the ETF's top holdings can be seen as negatively correlated to a rising dollar, there are other reasons to consider this fund even if the Fed boosts borrowing costs.

“Looking forward, to the extent we see a gradual rise in real rates, higher real rates are likely to keep small-cap valuations under pressure. Finally, according to Bloomberg data, large- and mega-cap names also have the advantage of cheaper valuations relative to the broader market,” said Koesterich.