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Summary

  • Despite struggles with the recovery in the Eurozone, the United Kingdom is on a more stable footing and represents solid value as an investment.
  • The iShares MSCI United Kingdom ETF is one of the largest region specific ETFs out there and represents the best choice for investment into the United Kingdom.
  • The region appears undervalued according to several valuation metrics including P/E, P/B and P/S. GDP quarterly growth has been solid while inflation has remained at bay.
  • Global diversification from several megacaps and a 3% dividend yield help cushion downside risk.

Investing in Europe carries its share of risk lately especially after the European Central Bank dropped a key lending rate below zero - a sure indication that it doesn't think that the Eurozone recovery is progressing well. Despite the struggles with growth, there are areas of Europe that are in better shape than others. The United Kingdom is one of those areas.

Unlike countries such as Spain, Greece and Italy that have struggled with GDP growth lately, the United Kingdom has held up relatively well.

(click to enlarge)

The United Kingdom has generated several quarters of solid economic growth and with inflation at a reasonable 1.9% annualized rate as of July 2014, the country appears to be on a steady growth path and that's important considering the uncertainty in the region. The best way to play the potential in the United Kingdom is through the iShares MSCI United Kingdom ETF (NYSEARCA:EWU).

The iShares MSCI United Kingdom ETF is actually one of the largest country specific ETFs out there with assets of around $4.3 billion. This ETF maintains positions in several of the largest brands out there like GlaxoSmithKline (NYSE:GSK), Royal Dutch Shell (NYSE:RDS.A), AstraZeneca (NYSE:AZN) and Vodafone (NASDAQ:VOD). The global nature of these megacaps helps limit overall risk exposure as evidenced by the fund's beta of 0.91.

From a valuation standpoint, current data suggests that this region is undervalued. The United Kingdom ETF has a trailing 12-month P/E ratio of just 14 - about 15-20% below its long-term multiple. Additionally, its current price/book ratio of 1.89 and price/sales ratio of 1.05 both indicate a portfolio that is cheap on a relative basis. Year-to-date, the iShares MSCI United Kingdom ETF is relatively flat but has outperformed the FTSE 100 in the most recent one- and two-year periods.

Adding to the potential of this ETF is the current 2.6% dividend yield that comes with the fund. Historically, the dividend yield has been nearer to 3% and has occasionally pushed the 4% level. The drop in yield could be at least partially explained by the performance of the ETF itself, which has returned almost 15% since the beginning of 2013.

Sharp eyes will likely notice the spike in the ETF's yield that occurred from roughly the end of June up until recently. This fund made a larger than normal dividend distribution of over $1.00 per share on June 25, 2014. The chart above details the ETF's 30-day yield and takes into account income earned during the prior 30 days. This large dividend results in a spike in yield up to around 6% for the subsequent 30-day period. After that 30-day period, the 30-day yield returns to a more typical number. The dividend yield that one can expect with this ETF - as is evidenced over the fund's history - is typically more around the 3% area.

There are risks to taking a position in the United Kingdom though. The Sharpe ratio of the U.K. ETF currently stands at 0.67 over the past three-year period indicating that the ETF hasn't done a good job of generating solid risk-adjusted returns. Additionally, while inflation remains at a reasonable level currently it has been creeping up over the last few months jumping to 1.9% annually from a recent low of 1.5%. This could potentially be an indicator that weakness in the Eurozone is beginning to creep into the British economy.

Conclusion

Weakness in the Eurozone has affected many countries in the region but the United Kingdom could very well be the best positioned of all of them right now. The iShares MSCI United Kingdom ETF counts several global leaders in their respective industries among its top holdings which helps eliminate unnecessary portfolio risk. It's a low to moderate risk investment, provides global diversification, appears to be relatively undervalued and carries a 3% dividend to boot.

The primary risk continues to be the Eurozone recovery. If that stalls or bleeds over to the U.K. then all bets are off. As it stands currently, however, this ETF could be a solid short and long-term play.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.