OEUR: Solidly Built Dividend Strategy, Though Tepid Performance, Low Yield (BATS:OEUR)

O’Shares FTSE Europe Quality Dividend ETF (OEUR) is a smart-beta investment vehicle mixing size, quality, volatility, and yield factors in a concentrated portfolio of European equities. For a fund investing in non-U.S. securities, it has an adequate expense ratio of 48 bps, which is slightly below the asset class median of 50 bps.

Though OEUR has a few strong advantages discussed below in the article, I highlight its soft past performance, a low standardized yield of only 1.5%, and exposure to the developed world currencies that face uncertain, more likely sluggish 2022 amid the tightening in the U.S. as the principal reasons for moderate skepticism. OEUR is a Hold.

Also, please take notice that earlier this month it has been announced that SS&C Technologies “has entered into an agreement to acquire O’Shares ETFs.” As clarified by Kevin O’Leary, chairman of O’Shares, in the press release, “the ETFs will continue tracking the proprietary indexes we developed, focusing on quality and preservation of capital,” so fundamental shifts in investment strategies are not to be expected.

Investment strategy

Incepted in August 2015, OEUR is supposed to provide exposure to the most resilient European companies capable of delivering surfeit profits and paying stable dividends, without frenetic price volatility that income-focused investors have reasons to steer clear of.

Before changing the benchmark to the O’Shares Europe Quality Dividend Index on June 1, 2020, the fund was tracking the FTSE Developed Europe Qual/Vol/Yield 5% Capped Factor Index.

The selection pool is the S-Network Europe Equity 500 Index, which encompasses large- and mid-cap companies. The universe is winnowed down using a few proprietary screens, including overall company quality, volatility, dividend yield, and dividend quality. Companies with brittle balance sheets and fickle margins are shown the red light. Those with unstable income and patchy DPS growth stories are likely to fail the dividend quality test.

Constituents’ weights depend on the mix of market cap and the above-mentioned factors, with an additional 5% cap. More details on the index rules can be found in the OEUR prospectus.

Holdings

As of January 26, OEUR’s portfolio encompassed 50 stocks, with the key dozen sporting an almost 36% weight. Though top-heaviness is a drag on the overall Risk profile, other ingredients like standard deviation and annualized volatility are fine.

Heavy in industrials (25.1%), healthcare (23.6%), and consumer staples (20.7%), OEUR intentionally ignores energy, materials, and real estate sectors, precisely like the O’Shares FTSE U.S. Quality Dividend ETF (OUSA), which I discussed in June 2021, with a neutral rating. These sectors were more likely removed from the selection universe due to capital-intensive operations and high debt load that go hand in hand and weigh on dividend stability and growth.

Unfortunately, there was no ‘country’ column in the dataset I pulled from the OEUR website, so I paired it with the one from the iShares Europe ETF (IEV), with which the O’Shares fund has approximately 35% overlap, as of my calculations.

The chart above shows OEUR is especially enamored of Swiss (23.4%) and French (20.6%) equities, with the UK (16%) being the third-largest allocation. By contrast, the S&P Europe 350 Index-tracking IEV is more UK-heavy, with the Alpine nation only in third place.

OEUR’s large exposure to the Swiss franc is the primary reason for skepticism. I have elaborated on bearish factors for this safe-haven currency in my article on the iShares MSCI Switzerland Capped ETF (EWL) published earlier this month, like the negative SNB policy rate with no prospects of hawkish moves in the medium term due to tepid inflation. EWL’s price has declined almost in line with the S&P 500 since then.

Obviously, among other key FX factors influencing OEUR’s NAV are the trajectories of the euro and the pound sterling. Scandinavian currencies have a much smaller impact. Danish equities provide what I would call quasi-exposure to the euro since the krone is pegged to it.

For the EUR, the outlook is less certain than for the CHF as the French economy is firing on all cylinders while Germany is teetering on the brink of a recession. This backdrop is anything but supportive of the ECB hiking rates soon. So the scenario in which investors abandon European bonds for higher and safer yields in the U.S. is valid.

OEUR’s essential investment with around 5.4% weight is Nestlé S.A. (OTCPK:NSRGY), a Swiss consumer staples behemoth. In the previous decade, its dividend was climbing steadily, from CHF 1.95 in 2011 to CHF 2.75 in 2021. The Zurich-listed stock is now yielding ~2.3%.

Speaking about French equities that OEUR is long, I like its exposure to high-margin luxury bellwethers LVMH (OTCPK:LVMHF), Kering (OTCPK:PPRUF), and Hermès (OTCPK:HESAF), which together account for around 7.3% of the net assets.

For instance, Louis Vuitton easily weathered the challenges of the pandemic, quickly returning to consistent growth. As its recently presented 2021 results illustrate, revenue for the period rose by mind-frazzling ~44% to €64.2 billion. For better context, the 2019 sales came at just €53.7 billion. Meanwhile, operating cash flow increased by 119% compared to 2019. On the back of impressive performance, the company decided to propose an annual dividend of €10 a share to the annual general meeting scheduled for April 21; this represents a startling ~67% increase over the 2020 DPS.

Performance

From 1 June 2020 (when the underlying index was changed) to 31 December 2021, OEUR delivered a compound annual growth rate of 24.4%, underperforming its U.S.-focused counterpart OUSA, as well as the S&P 500 (IVV), EWL, and the iShares MSCI France ETF (EWQ). The latter is overweight in LVMH and TotalEnergies (TTE), which both more likely grossly impacted its CAGR of close to 33%, supported by the economic revival, pent-up demand, and the energy market imbalances. That is especially disappointing considering OEUR’s standardized yield is only marginally above EWQ’s, 1.51% vs. 1.27%.

Its YTD performance is the worst in the group.

To bring a bit more color, I have compared the most recent prices of OEUR and all the 44 dividend ETFs I have covered on Seeking Alpha to date with their 52-week highs. The results are unpleasant again. Unfortunately, OEUR had one of the steepest declines, with only Global X SuperDividend (SDIV), Vanguard International Dividend Appreciation (VIGI), Global X SuperDividend Emerging Markets (SDEM), and WisdomTree International SmallCap Dividend (DLS) ETFs having softer performance, down by close to 17.3%, 15.6%, 15.4%, and 12.5%, respectively. OEUR fell by around 11.4% from its 52-weak peak, while the most resilient is the WisdomTree U.S. High Dividend Fund (DHS) which has retreated by only ~1.9%.

Final thoughts

In sum, OEUR offers a high-quality mix tilting towards Swiss and French equities, favoring industrials and healthcare and completely ignoring capital-intensive energy, materials, and real estate. Its expenses are relatively comfortable.

OEUR’s indubitable advantages are carefully calibrated methodology revolving around quality and exposure to resilient, wide-moat behemoths with sturdy balance sheets. The essential drawbacks are soft past performance, low yield, and potential headwinds stemming from the CHF and the euro-denominated investments. While appreciating OEUR’s scrupulous fundamental analysis, I give it a Hold rating.