British ETFs In Focus On Brexit Talks

Includes: EWU, EWUS, FKU, FXB, GBB
by: Zacks Funds

"Should the United Kingdom remain a member of the European Union or leave the European Union?" This is the question Britain will be voting on June 23, making it the biggest strategic decision in decades.

The UK Prime Minister David Cameron's decision to conduct the country's in/out referendum on EU membership follows the conclusion of the renegotiation of UK's position within the EU at the European summit. During the summit, Cameron negotiated a deal to give Britain "special status in the EU," which includes power to limit some EU migrants' benefits. Cameron, who won the general election in 2015, had promised to hold an in/out referendum on EU membership no later than the end of 2017 in his campaign.

There has been a steady rise in Eurosceptics over the past decade pressing for a referendum largely because of Europe's migration crisis and continued Eurozone travails. Although chances of Brexit were slim a couple of years back, the perpetual problems in the EU have over time narrowed the polls. As per a poll conducted by ICM, while 39% would choose to leave, 43% want to remain in the EU and the rest are undecided.

However, British businesses are largely in favor of remaining in the EU. The Institute of Directors (IoD) and the EEF - the manufacturers' organization, which collectively represents the interests of 40,000 companies across the UK - stated that polls showed more than 60% of the members are in favor of remaining in the EU, while 30% of IoD members and 5% of EEF members backed Brexit.

Market Impact

As the possibility of UK's exit from the EU intensified after London mayor Boris Johnson joined the campaign, the pound tumbled to a seven-year low against the dollar. The currency fell 2.3% to $1.4067 on February 22, 2016, its biggest one-day fall since early 2009. The pound also weakened against other major currencies as investors pulled money away from UK assets.

Apart from the pound, the euro could also come under pressure against other major currencies if the second-largest EU economy makes its exit, shaking investor confidence in an already weak Europe.

Many market participants believe a "Brexit" would lead to a weaker currency owing to worries about Britain's £229 billion annual trade with the EU, which could suffer if new trade barriers are raised. One of the major advantages of the EU is free trade between member nations, which makes exporting goods to other EU countries easier and cheaper for British companies. Thus, Brexit could have a negative impact on Britain's GDP. Lower GDP growth and tougher export conditions would hit several sectors like retail and financial services among others and therefore have an unfavorable impact on British equities.

On the other side of the coin, the country could form deeper ties with other countries outside the EU. However, it can't be exactly predicted what would happen if Britain exits the EU, as there has been no precedence. Although there were talks of a Greek exit last year owing to the debt crisis, the debacle was finally averted by a deal reached between the country and its European creditors.

Moody's believes the economic costs would more than offset the benefits if Britain chooses to leave the EU. The agency even stated that it would consider assigning a "negative outlook" to UK's current Aa1 rating with a "stable" outlook now, which would imply a higher chance of a downgrade in the future.

With the market already pricing in some probability of Brexit, a contrary outcome could result in the rise of the sterling and outperforming equities.

Whether the UK will ultimately choose Brexit or select to remain in the EU remains to be seen. But polls and political propaganda are likely to continue to stimulate uncertainty in the short term. In this scenario, we highlight three ETFs that are primarily exposed to British equities and two sterling currency funds, which are likely to be on investors' radar in the coming days.

iShares MSCI United Kingdom ETF (NYSEARCA:EWU)

This product tracks the MSCI United Kingdom Index. In total, it holds 112 securities with almost 40% of its assets allocated to the top 10 holdings. EWU is popular and actively traded with AUM of $2.2 billion and average daily volume of more than 3.7 million shares. From a sector look, financials takes the top spot at 20.7% while consumer staples, energy, consumer discretionary, and healthcare round off the top five. The ETF charges 47 bps in annual fees. It has a Zacks Rank #2 (Buy) with a Medium risk outlook. The fund gained 0.1% on February 22, 2016, and is down 6.4% in the year-to-date period.

First Trust United Kingdom AlphaDEX ETF (NASDAQ:FKU)

This fund provides exposure to 75 firms by tracking the NASDAQ AlphaDEX United Kingdom Index. The fund has amassed $149.5 million in its asset base while it has an average daily volume of more than 38,000 shares. None of the firms accounts for more than 2.6% of the total assets.

Sector-wise, financials takes the top spot at about 32% share while consumer discretionary and industrials also have double-digit allocation. FKU charges a fee of 80 bps annually and has a Zacks Rank #3 (Hold) with a Medium risk outlook. The fund fell 1.3% on Monday and has lost 11.6% since the beginning of the year.

iShares MSCI United Kingdom Small-Cap Index ETF (BATS:EWUS)

With AUM of $14.2 million, this product tracks the MSCI United Kingdom Small Cap Index. In total, it has a diversified portfolio of 241 securities with none of the components holding more than 2.1% weight. From a sector look, consumer discretionary takes the top spot at 23.3%, while financials, industrials, information technology and materials round off the top five. The ETF has an expense ratio of 0.59% and trades in light volume of around 3,000 shares a day. The fund lost 1.04% in the last trading session and 11% so far this year (as of February 22, 2016).

CurrencyShares British Pound Sterling Trust ETF (NYSEARCA:FXB)

The fund tracks the price of the British Pound Sterling. With the UK currency in a tight spot, the fund lost 1.5% on February 22, 2016, and 4.1% so far in 2016. With AUM of $48.9 million, it is the most popular pound ETF. The ETF has an expense ratio of 0.40% and trades in volume of around 16,000 shares a day.

iPath GBP/USD Exchange Rate ETN (NYSEARCA:GBB)

With AUM of $3 million, the fund provides exposure to the British pound/U.S. dollar exchange rate. The fund lost 1.8% on February 22, 2016, and 4.7% in 2016. The ETF has an expense ratio of 0.40% and trades in light volume of less 1,000 shares a day.

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