More than three years after being approved, Brexit, Great Britain’s plan to depart the European Union (EU), is still an issue for financial markets and global investors to contend with. Here’s the lay of the land as of today, but as Brexit history has taught investors, things can change in a heartbeat: Prime Minister Boris Johnson has called an election for Dec. 12, ahead of the scheduled departure date of Jan. 31, 2020.
However, previous deadlines for the U.K. to leave the EU have been consistently pushed back and scrapped, so only time will tell if Jan. 31 holds this time around.
In the aforementioned election, Johnson squares off against the Labour Party’s Jeremy Corbyn, but four parties are competing in the election and muddying the waters, with Johnson warning voters that a vote for any party other than the conservative regime currently in power is akin to a vote for Corbyn.
Amid ample Brexit controversy and squabbling this year, U.K. stocks have been decent performers. The FTSE 100 Index sports a double-digit year-to-date gain while the MSCI United Kingdom Index is higher by 11.8%.
Still, those performances lag what investors have gained here in the U.S. So with no guarantees that Brexit will happen or that headline risk will ebb anytime soon, investors may want to consider avoiding the following U.K. ETFs.
iShares MSCI United Kingdom ETF (EWU)
Expense ratio: 0.47% per year, or $47 on a $10,000 investment.
The iShares MSCI United Kingdom ETF (NYSEARCA:EWU) is the largest U.K. ETF trading in the U.S. and tracks the aforementioned MSCI United Kingdom Index, meaning its returns have been admirable this year.
As far ex-U.S. developed market funds go, EWU is one of the less volatile options with a three-year standard deviation of just 12.4%. With a trailing 12-month dividend yield of 4.59%, it’s easy to understand why yield-starved U.S. investors may find this U.K. ETF compelling. However, there is Brexit risk with EWU and it pertains to the EU revenue exposure of FTSE 100 components, many of which also call this U.K. ETF home.
“Companies in industries with high revenue exposure to Europe may be impacted by Brexit more than companies in industries with low revenue exposure to Europe,” said FactSet. “The revenue exposure of the FTSE 100 to Europe is about 40%, which is the highest revenue exposure in the index to any super-region. After Europe, the FTSE 100 has the highest revenue exposures to the Americas (31%) and Asia Pacific (24%) super-regions.”
iShares MSCI United Kingdom Small-Cap ETF (EWUS)
Expense ratio: 0.59%
The small-cap counterparts to the large-cap EWU, the iShares MSCI United Kingdom Small-Cap ETF (CBOE:EWUS) deserves some credit because it has returned more than 19% year-to-date, proving somewhat immune to Brexit wranglings. However, that immunity is not guaranteed and the volatility associated with smaller stocks could make this U.K. ETF vulnerable if Brexit talks or election results take unexpected turns for the worse.
As is the case in the U.S., U.K. small-cap stocks are heavily focused on the domestic economy, but that adds some risk to EWUS if Brexit turns sour.
“Many investors have steered clear of small cap stocks since the referendum of 2016,” according to Morningstar. “Typically, these businesses are more domestically focused – unlike their large cap counterparts which get much of their earnings from overseas – making them more vulnerable to any slowdown in the UK economy or drop in consumer confidence.”
With Brexit headline risk looming, investors appear content to steer clear of small caps, not exactly endorsing EWUS and other U.K. ETFs in the process.
“UK equities continue to be one of the most underweighted asset classes and sentiment among UK investors remains near an all-time low,” said Morningstar.
First Trust United Kingdom AlphaDEX Fund (FKU)
Expense ratio: 0.80%
Up more than 18% this year, the First Trust United Kingdom AlphaDEX Fund (NASDAQ:FKU) has been a star among U.K. ETFs, but investors shouldn’t be seduced by that performance. At least not until Brexit’s fate is finalized.
What makes FKU potentially vulnerable as Brexit uncertainties mount is its sector exposure. “At the industry level, the Telecommunications (-39%) and Utilities (-22%) industries are the only two industries that have reported price declines since the Brexit vote,” according to FactSet.
Those sectors combine for about 9.5% of FKU’s weight, which isn’t much — but wait, there’s more. Consumer discretionary, consumer staples and financial services stocks are also viewed as “Brexit vulnerable” and those sectors combine for almost 40% of FKU’s roster. That’s enough to warrant a cautious approach with this U.K. ETF.
As of this writing, Todd Shriber did not hold a position in any of the aforementioned securities.
