What is FEP? (Pros, Cons, and Strategies)

The world of exchange-traded funds (ETFs) offers numerous options tailored to different investment objectives, and the First Trust Europe AlphaDEX Fund (FEP) is one such financial instrument. Whether you're looking to diversify your portfolio or gain exposure to European markets, FEP can provide a viable solution. In this blog post, we'll dive into what FEP is, its pros and cons, and some effective strategies for investing in this Europe-centric ETF.

What is FEP?

FEP, or the First Trust Europe AlphaDEX Fund, is an ETF that aims to provide investors with capital appreciation by tracking the performance of the NASDAQ AlphaDEX Europe Index. Unlike traditional market capitalization-weighted indices, the AlphaDEX methodology selects and weights stocks based on certain fundamental factors, aiming to outperform the broader market.

Key Features of FEP

• Fundamental-Based Selection: Stocks are chosen based on a combination of growth factors (e.g., earnings momentum, price appreciation) and value factors (e.g., book value, cash flow).
• Diversified Exposure: The fund provides diversified exposure to various sectors including financials, healthcare, industrials, and consumer discretionary.
• Growth and Value Focus: By incorporating both growth and value metrics, FEP seeks to capture market inefficiencies for better returns.

FEP Composition

FEP's portfolio includes a mix of well-established European companies across multiple sectors. Notable holdings might include large-cap companies such as Allianz SE, Roche Holding AG, and Nestlé SA. The sector allocation is dynamic, aiming to take advantage of companies that exhibit both growth potential and value.

Pros of FEP

Diversified International Exposure

Investing in FEP provides exposure to the European market, which can add geographic diversification to a predominantly US-centric portfolio. This is particularly useful for mitigating country-specific risks and capitalizing on growth opportunities in Europe.

Fundamental Indexing Advantage

The AlphaDEX methodology screens and weights stocks based on fundamental factors rather than just market cap. This provides an opportunity to potentially outperform traditional benchmark indices by focusing on stocks that exhibit favorable growth and value characteristics.

Sector Diversification

FEP's structure spans various sectors, reducing the risk associated with investing in a single industry. This diversification enhances the fund’s stability, making it a less volatile option for investors during market fluctuations.

Potential for Outperformance

Given its focus on both growth and value metrics, FEP has the potential to outperform the broader market over the long term. The fund is designed to exploit market inefficiencies and identify companies with strong fundamentals and growth prospects.

Cons of FEP

High Expense Ratio

Compared to some passive ETFs, FEP's expense ratio may be relatively higher. This could erode net returns over time, especially when compounded over many years.

Currency Risk

As an international fund, FEP exposes US investors to currency risk. Fluctuations in the exchange rates between the US dollar and European currencies can impact returns, adding another layer of risk.

Market and Economic Conditions

FEP’s performance is directly influenced by the economic conditions in Europe. Political instability, economic slowdowns, or adverse regulatory changes in the region can negatively affect the fund's returns.

Limited Short-term Gains

Similar to other fundamentally-weighted ETFs, FEP might not be suitable for short-term investors seeking quick gains. The fund is better suited for long-term, buy-and-hold strategies.

FEP Investment Strategies

Incorporating FEP into your investment strategy can offer diversified exposure to European markets with a potential for outperformance. Here are some strategies to consider:

Long-term Growth Strategy

Given FEP’s fundamental indexing approach, it is ideally suited for long-term investment horizons. Aiming to capture both growth and value opportunities, this ETF can be a cornerstone for those planning to hold investments for at least 5-10 years. Over time, the diversification and sector weighting can yield steady returns.

Diversification Strategy

If your portfolio is heavily concentrated in US equities or other regions, adding FEP can provide a geographical balance. While US markets have shown strong performance, diversifying into European markets can offer new growth opportunities and mitigate regional risks.

Income Generation Strategy

Although primarily focused on capital appreciation, FEP also includes companies that pay dividends. Therefore, reinvesting dividends can harness the power of compounding returns, making it a suitable option for income-focused investors.

Dollar-Cost Averaging

To mitigate the risks associated with market volatility, consider employing a dollar-cost averaging (DCA) strategy. Regularly investing a fixed amount into FEP regardless of market conditions can average out the purchase price over time, reducing the impact of short-term market fluctuations.

Hybrid Growth and Value Strategy

By combining FEP with other ETFs or investments focused on different regions or sectors, you can create a hybrid strategy that balances growth and value. This approach can potentially optimize returns while minimizing risks through diversified investments.

Conclusion

FEP is a robust ETF that offers diversified exposure to European markets with a fundamental indexing twist. Its potential for long-term outperformance and diversified sector exposure make it a compelling option for investors seeking geographical diversification and capital appreciation. However, the higher expense ratio, currency risk, and vulnerability to European economic conditions are factors to consider. With well-thought-out strategies such as long-term investment, diversification, and dollar-cost averaging, FEP can be a valuable component in a diversified investment portfolio.

Investing is always subject to risks, and it's crucial to conduct thorough research or consult with a financial advisor to align FEP with your individual investment goals and risk tolerance.