A Small ETF With Big Strong Dollar Potential

The dollar is getting stronger. The PowerShares DB US Dollar Index Bullish Fund UUP is up 2.37 percent over the past week and is sporting a second-quarter gain of nearly 5 percent.

It may take a lengthier rally by the greenback to reinvigorate investors' interest in currency-hedged exchange traded funds, or ETFs designed to benefit from dollar weakness. Investors willing to bet on a continued surge in the dollar may want to consider an overlooked ETF: the iShares Currency Hedged MSCI Europe Small-Cap ETF HEUS.

What Happened

Just five ETFs hit 52-week highs on Wednesday. Four were energy funds, while HEUS was the other. That extends HEUS' year-to-date gain to more than 4 percent.

HEUS “seeks to track the investment results of an index composed of small-capitalization European developed market equities while mitigating exposure to fluctuations between the value of the component currencies and the U.S. dollar,” according to iShares.

The ETF, which debuted in October 2015, tracks the MSCI Europe Small Cap 100% Hedged to USD Index. Up to this point in its lifespan, HEUS has been mostly overlooked by investors — as evidenced by its mere $3.06 million in assets under management.

Why It's Important

Size alone is the not a primary determinant of an ETF's ability to potentially deliver impressive returns for investors. HEUS holds the iShares MSCI Europe Small-Cap ETF IEUS, which $260.43 million in assets under management, with a currency-hedged overlay.

Interestingly, IEUS has slightly outperformed the Russell 2000 Index this year while being less volatile. Additionally, European small-caps, as measured by HEUS and IEUS, trade at significantly lower valuations than U.S. small stocks.

What's Next

HEUS would generate more upside for investors if European small-caps strengthen alongside the dollar. At the geographic level, the fund devotes over 32 percent of its weight to the U.K., implying that a stronger pound and/or rate hikes by the Bank of England could be punitive.

Of the roughly 15 countries represented in HEUS, about 10 are Eurozone economies, so a weaker euro would also be potentially beneficial to HEUS. The industrial, consumer discretionary, financial services and technology sectors combine for 61 percent of the fund's weight, indicating that a flight to European cyclical fare could also provide a lift.

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