What A Brexit Could Mean For U.K. ETFs

The CurrencyShares British Pound Sterling Trust FXB is down 2.6 percent year-to-date, good for one of the worst performances among developed market currency exchange traded funds. The iShares MSCI United Kingdom ETF EWU is off 2.8 percent.

Combine those showings and it is apparent that financial markets are not enthusiastic about the prospects of a “Brexit,” or Great Britain's potential departure from the European Union. Britons will decide on that issue in a referendum to be held in late June. Uncertainty over the outcome is already having an impact on U.K. stocks, the local economy and sterling, as highlighted by EWU and FXB.

“The result of the referendum may be a close call, and uncertainty about the outcome is already having an impact on the U.K. economy. On February 22, for instance, the sterling tumbled to a seven-year low against the dollar, according to Bloomberg data, after London Mayor Boris Johnson came out in support of the 'leave' option,” according to a recent BlackRock note.

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.

Investors are displaying plenty of concerns regarding a Brexit as highlighted by the $165.1 million pulled from EWU year-to-date. EWU's currency hedged equivalent, the iShares Currency Hedged MSCI United Kingdom HEWU has lost about $3.3 million in assets.

“We believe it’s a good idea that the U.K. stay in the EU. The economic and financial costs of a Brexit are material for the U.K., in our final analysis, both in the near and long term. And it’s not just the U.K. economy that would feel the effects of Brexit: The EU would lose a world-class financial center, a major budget contributor, a defense pillar and a leading voice for free markets,” adds BlackRock.

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.