With Great Britain's referendum on its future in the European Union slated for late June, there is increasing talk regarding which corners of the UK's financial markets are vulnerable. That speculation carries over to U.S.-listed exchange-traded funds such as the Guggenheim CurrencyShares British (NYSE: FXB) and the iShares MSCI United Kingdom ETF (iShares Trust (NYSE: EWU)).
A “Brexit,” is widely believed to be pound negative, explaining why FXB is down 3.8 percent year-to-date, and is one of this year's worst-performing developed market currency ETFs.
Related Link: Here's How A Brexit Could Screw Up The Economy
Hedging Brexit Chatter Outcomes
Citigroup suggests several Brexit hedges, including overweighting energy names relative to financials. EWU allocates 21 percent of its weight to the financial services sector and nearly 13 percent to energy names. There is risk in overweighting European energy names, namely a murky dividend outlook for the UK's benchmark FTSE 100, which, though it has yet to, could eventually plague oil majors residing in EWU.
Other ETFs, such as the Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBX ETF Trust (NYSE: DBEF)), could benefit if Brexit comes to pass, particularly if sterling falters but UK equities firm up.
“According to a YouGov poll conducted last week, a roughly equal percentage of respondents in the U.K. intend to vote to leave the European Union (EU) as intend to vote to remain; one quarter of them don't know or will not vote in the June referendum. In anticipation of a possible 'Brexit', the British pound weakened relative to the U.S. dollar in February,” said S&P Capital IQ in a note out Thursday.
Why DBEF Deserves A Second Look
At almost 19.6 percent, the U.K. is DBEF's second-largest country weight behind Japan.
"Within consumer staples, large multinationals such as Unilever (UL) and Diageo (DEO) can benefit as a weaker pound generates higher profits. For example, Unilever recorded strong revenue growth of 10 percent in 2015, boosted by a positive currency impact of 6 percent. However, S&P Global Market Intelligence analyst Julien Jarmoszko notes that U.K. supermarkets such as Tesco could be hurt by higher food costs as the pound weakens that they are unable to pass along price increases to customers amid high competition,” said S&P Capital IQ.
DBEF allocates over 12 percent of its weight to staples stocks, several of which are British names. The ETF is down 5.6 percent year-to-date, but up 2.8 percent over the past month.
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