‘Brexit’ Lifts UK Currency Hedged ETFs

February 24, 2016

For the past few years, as the dollar strengthened against a host of falling currencies across the globe, the use and creation of currency-hedged ETFs listed in the U.S. has flourished. Advisors and investors have come to understand the need to protect international exposure with these tools.

Japan, the eurozone and most recently, China, have been hotbeds for U.S. investors using currency-hedged ETFs. But a strong pound in the United Kingdom relative to the euro and even the U.S. dollar has kept the country off the currency-hedged radar; that is, until just a few days ago.

Over the weekend, Prime Minister David Cameron set a referendum date for June 23 on whether the country should remain in the European Union after he struck a deal on Friday to give Britain “special status” within the EU in his attempt to keep the country inside the union.

Polls show that country is polarized by the issue, with many voters still undecided. Then, on Sunday, London Mayor Boris Johnson said he would split with Cameron and campaign for the country to leave the European Union.

Those events have sent the pound reeling to its lowest levels since 2009 against the dollar and even the euro, as investors fret over the potential economic fallout of such a break.

Uncertainty A Currency Weight
On Tuesday, according to Reuters, 36 of the bosses of FTSE 100 companies—including oil giants Shell, BP and its largest telecoms group—said leaving the EU would put the economy at risk, backing Prime Minister David Cameron's call to stay in the bloc.

"Business needs unrestricted access to the European market of 500 million people in order to continue to grow, invest and create jobs," said the letter, published in the Times newspaper on Tuesday. "We believe that leaving the EU would deter investment, threaten jobs and put the economy at risk."

Others chimed in on what they see as a further weight on the country’s currency: uncertainty.

"From a market perspective, the most likely barometer of uncertainty is the currency, and ... we believe there is significant further downside potential for sterling in the buildup to the vote," wrote UBS economist David Tinsley in a note.

If the trend is an investor’s friend, it looks like a weakening pound will be a theme that will carry itself into the election at the end of June.

While the need for currency-hedged ETFs hasn’t been as apparent in the U.K. as other parts of the world, they were not ignored by the three biggest issuers of those types of products. Deutsche Bank, iShares and Wisdom Tree in the last few years have all launched currency-hedged ETFs focused on the UK, although they have been slow to attract assets.

U.K. Currency-Hedged ETFs

The largest, with $30 million in assets, is the WisdomTree United Kingdom Hedged Equity (DXPS | C-61), which was launched almost 2 ½ years ago. The Deutsche X-trackers MSCI United Kingdom Hedged Equity ETF (DBUK | C-64) was also launched in 2013, and the newcomer, the iShares Currency Hedged MSCI United Kingdom (HEWU | F-42), was launched last year. DBUK and HEWU both have modest assets—under $5 million.

However, the three funds have been outperforming their unhedged and larger counterparts, which include the $2 billion iShares MSCI United Kingdom (EWU | B-88) and the $150 million First Trust United Kingdom AlphaDex (FKU | D-59).

Chart courtesy of StockCharts.com

While ETF assets by U.S. investors into the U.K. space is relatively small, a break from the EU could put the country clearly in the focus of investors hoping to capitalize on a vote to break away, which would seemingly lift the currency-hedged funds, or the unhedged products, if the vote is to remain.

Either way, one thing is clear: The ETF industry’s innovation in the currency-hedged space over the last few years put in place tools that investors can use to play either side of the fence.

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