What U.K. ETFs Are Saying About Brexit

Markets Benzinga

With the Brexit vote determining Great Britain's fate in the European Union (EU) drawing closer, now is a good time to check in with U.K. exchange-traded funds, some of which have been under pressure due to intensifying Brexit speculation.

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Financial markets are not enthusiastic about the prospects of a Brexit, or Great Britain's potential departure from the European Union, but as measured by the iShares MSCI United Kingdom ETF (iShares Trust (EWU)), U.K. stocks are enduring the controversy. Over the past month, EWU, the largest U.K. ETF trading in the United States is higher by 3.3 percent.

Pound Negative

Although a Brexit is almost universally seen as pound negative, the Guggenheim CurrencyShares British (FXB) is up a third of a percent over the past month. However, FXB, which tracks sterling's moves against the U.S. dollar, is down more than 2 percent this year. That confirms the fears of many currency market participants who believe if Brexit comes to pass, the pound's losses could be substantial.

Related Link: Lots Of Talk About The Brexit, But What Do Traders Think?

A Brexit is also widely seen as bad for the pound, and some estimates are bold enough to call for a 20 percent to 30 percent drop for the British currency is Brexit comes to pass, making FXB's current decline appear modest.

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In addition, a leave vote would likely shock global markets. We believe risk assets including stocks and credit would suffer in the resulting risk-off environment, as concerns about political instability and a reversing globalization trend would lead to higher risk premiums, said BlackRock in a recent note.

What Else Would A Brexit Mean?

Peripheral European assets and the global financials and materials equity sectors would be especially exposed, according to our stress-test analysis. Political risk could also rise amid uncertainty over the succession to British Prime Minister David Cameron. Safe-haven investments would benefit, we believe.

Other data points suggest Brexit speculation is hampering U.K. companies.

More than one-in-three companies report that uncertainty over the outcome of the EU referendum is having a detrimental effect on their business. One-in-twelve firms report a strongly detrimental impact, according to Markit.

Historically, EWU is not a volatile ETF. The fund has a three-year standard deviation of just 14.6 percent and allocates 30.5 percent of its weight to lower beta consumer staples and healthcare names, a trait that pumps the ETF's dividend yield north of 4 percent.

What if the U.K. votes to stay? We see risk assets rallying, safe-haven assets suffering, the pound getting a boost and market attention turning to the upcoming U.S. presidential election. The key for the next few weeks: Caution. We believe now is a good time to dial down equity and credit risk, and U.K. investors may want to put in place hedges against a potential Brexit outcome, added BlackRock.

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