What U.K. ETFs Are Saying About Brexit

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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.

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 (NYSE: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.

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Pound Negative

Although a Brexit is almost universally seen as pound negative, the Guggenheim CurrencyShares British (NYSE: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.

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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