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By Matt Hougan

CNBC asked me on air Thursday to discuss how European ETFs have been performing and what looks attractive from here. My short answer was that European ETFs have been getting clobbered.

Investors have been hit by the one-two punch of a falling European market and a falling currency. Of the two, currency has been the bigger problem.

Remember: Every international equity investment is a bet on both the market and the currency. If you buy a broad-based eurozone ETF like the iShares MSCI EMU ETF (EZU) and the European market rallies 5 percent, but the euro falls 10 percent, you’ve still lost money.

Total returns, after all, are the sum of market returns plus or minus currency returns

Usually, market returns overwhelm the impact of currency, but that hasn’t been the case recently. Through yesterday, the local version of the MSCI European Monetary Union Index was only down about 9 percent on the year, but the dollar version (and the EZU ETF) has fallen 22 percent, because the euro has been crushed year-to-date.

There are a few clever new ETFs that account for this. I didn’t get to mention them on air, but WisdomTree has two ETFs that hedge out the currency risk: the WisdomTree International Hedged Equity ETF (HEDJ) and the WisdomTree Japan Hedged Equity ETF (DXJ). Both give you pure exposure to the local returns of the benchmark indexes.

HEDJ is interesting because WisdomTree also offers a sister fund that tracks the same index but doesn’t hedge out currency, the WisdomTree DEFA ETF (DWM). Year-to-date, HEDJ has outperformed DWM by more than 12 percent.

click to enlarge

HEDJ vs. DWM - 2010 YTD

Unfortunately, there’s currently no European-only equity fund offering hedged exposure to the market. HEDJ is about two-thirds Europe, with the remainder of the fund scattered among Japan, Australia, China and other Asian regions.

So, before you go jumping into European stocks, remember that you’re making a big bet on the euro. That may be a good thing in the short term—many signs point toward at least a temporary snapback rally in the euro. But over the longer term, I don’t know if it’s such a good place to be.

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Source: Interested in Europe? Remember the Euro