The impending United Kingdom referendum on European Union membership remains a major “event risk” for global markets over the coming month. That said, polling suggests the chances of the UK leaving the Union after this vote are diminishing, which means there might be scope for at least a short-term “relief rally” for the British Pound. More broadly, however, it’s worth noting that UK equities have underperformed their continental counterparts in recent years, and lingering concerns over the UK’s commitment to the European Union suggests investors might consider European investments that exclude the United Kingdom.
Odds Favour the “Stay” Vote
Probably even more telling are the results from betting markets. Although traditional polling still suggests a relatively close result, especially with a critical group still undecided, betting markets have long suspected the “stay” vote was much more likely to win. Indeed, the probability of the “stay ” vote prevailing has generally increased since the referendum was officially announced on 20 February.
The Pound Could Bounce
UK Equities have underperformed
Longer-term, however, the UK’s wavering support for EU membership does pose some political risks. Some companies seeking a foothold in Europe, for example, may come to question basing the centre of their operations in the United Kingdom. London’s role as a European financial centre could also come under greater scrutiny.
Against this background, it’s also worth noting that the UK equity market has generally underperformed that of the Euro-zone in recent years. One factor is the UK’s generally higher exposure to mining and energy stocks, which have suffered due to the decline in global commodity prices. Another factor has been more aggressive monetary stimulus from the European Central Bank, which has also contributed to relative weakness in the Euro against the Pound and improved Euro-zone export competitiveness. Indeed, it remains the case that the ECB President Mario Draghi has promised to do “whatever it takes” to avoid deflation taking hold in the Euro zone, which could mean even more quantitative easing and Euro weakness going forward.
Investment Implications: Currency and Equity Investment Opportunities
For investors that want exposure to a possibly rising British Pound, the BetaShares British Pound ETF (ASX Code: POU), can be bought and sold on the Australian Securities Exchange (ASX) just as easily as a company share. By primarily investing in bank deposit accounts denominated in British Pounds, POU aims to track the change in price of the British Pound relative to the Australian dollar. If the British Pound goes up 10% against the A$ (i.e. the A$ falls in value), for example, POU is designed to go up 10% too, before fees and expenses. Obviously if the reverse occurs and the Pound was to fall in value relative to the Australian dollar, the value of POU would fall too.
For investors interested in investing in Europe but who may be concerned over the UK equity outlook, the BetaShares WisdomTree Europe ETF – Currency Hedged (ASX Code: HEUR) provides exposure to Eurozone equity markets (and hence excludes UK companies). This ETF also has the feature of being currency hedged, which guards against the risk of possibly significant future Euro exchange rate weakness should the ECB need to ramp up its quantitative easing program dramatically further.
Like all BetaShares Funds, HEUR is also an Australian domiciled fund. Therefore, investors in HEUR do not need to fill out W-8 BEN forms, or risk any potential U.S. estate tax issues, unlike investors in “cross listed” alternative exposures.