3 ETFs To Play Recovery In The UK Economy

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September 19, 2013 1:47pm BATS:EWUS NASDAQ:DXPS

uk united kingdomThough August was a rough month for global equities, European stocks have shown strong recovery on the back of upbeat data, less concerns on debt levels and a firmer currency. The Euro zone has finally emerged out of its six-quarter long

recession and is slowly improving now(read: 4 Outperforming ETFs Leading Europe Higher).

The UK is leading the way in the broad European recovery, having easily dodged the triple dip recession. The economy surprisingly picked up growth at 0.7% in the second quarter, up from 0.3% in the first quarter buoyed by rising housing prices and increasing consumer confidence. The expansion was broad based with services, manufacturing and construction all turning to strong growth.

According to data from Markit, the service sector grew in two months back to back and at the fastest pace in six years in August. Manufacturing activity also expanded to two and half year high while construction sector improved since June 2010.

The series of solid data was welcomed by investors, suggesting growing optimism on the economy.

Bright Outlook

The Organization for Economic Co-operation and Development (OECD) expects the economy to grow 1.7% in the second half of the year and outstrip the larger Euro zone economies.
Additionally, the international agency lifted its growth outlook to 1.5% from 0.8% for this year while the IMF expects the economy to expand from 0.6% to 0.9% this year.

Despite the fact that the country lost its AAA credit rating from two major agencies (Fitch and Moody) earlier this year, it poses an extremely strong credit profile, higher transparency, flexible monetary policy as well as high degree of political and social stability.

Further, unemployment remained unchanged at 7.8% in the second quarter. Inflation seems to be under control and is slowly cooling off to touch the 2% target set by the Bank of England. In fact the Inflation fell to 2.8% in July.

Moreover, the currency, British Pound, is showing resiliency when other European currencies are struggling. The British Pound gained over 2% against the greenback over the past two months (see more in the Zacks ETF Center).

Major Threats

Although Britain is currently the fastest growing nation in Europe, it is by no means risk free. The country continues to have one of the highest budget deficits in the European Union at nearly 6% of GDP. In fact, the country’s trade balance dropped to $9.85 billion for August against the analyst expectation of $8.15 billion, but was up from $8.17 billion in July.

Additionally, the national debt level is persistently rising and expected to cross 100% of GDP in 2015–2016, but then decline gradually from 2017–2018. Further, real GDP is not expected to return to the 2007 level until 2014, suggesting that it could still be a while before Britain reaches its pre-recession heights.

These factors would continue to weigh on British recovery and pose major threats to economic growth (read: Are UK ETFs in Serious Trouble?).

How to Play

Considering the pros and cons, investors seeking to tap the country could choose from the following three ETFs. These products have provided handsome returns so far this year and could continue to trend higher if the UK economy improves further.

iShares MSCI UK Index Fund (EWU)

This fund is by far the most popular and liquid ETF tracking the British economy with AUM of $2.7 billion and average daily volume of nearly 2.1 million shares. It tracks the MSCI United Kingdom Index and holds 108 securities in its basket. The fund charges 50 bps in fees per year from investors.

The product does a decent job of spreading assets, as not even a single stock in the basket makes up more than 7.57% of the portfolio. From a sector look, financials is the top sector at 21.08%, closely followed by energy (16.34%) and consumer staples (16.30%). The ETF added over 8% so far this year.

WisdomTree United Kingdom Hedged Equity Fund (DXPS)

The newest entrant in the UK space comes from WisdomTree and its DXPS. The fund offers a unique way to capitalize the returns from the leading U.K. firms while hedging exposure to the British pound by tracking the WisdomTree United Kingdom Hedged Equity Index.

The fund manages a basket of 137 stocks and is well spread out across each security with none holding more than 5.7%. In terms of sector exposure, consumer staples, financials, energy and materials round off to the top four with double-digit allocations.

The ETF often seeks to outperform when the pound weakens and underperform when the pound is surging against the U.S. dollar. DXPS has garnered enough investor interest and accumulated $37.9 million in total assets in just two months of its launch. The fund charges 48 bps in fees per year and is up 5.3% since inception.

iShares MSCI United Kingdom Small Cap (EWUS)

This product targets the small cap segment of the UK markets by tracking the MSCI United Kingdom Small Cap Index. The product has amassed $9.1 million in its asset base while volume is light trading in less than 4,000. It charges 59 bps in fees from investors a year.

In total, the ETF holds 235 securities in its basket and allocates its assets uniformly across all securities ensuring that concentration risk is diversified. However, the fund is skewed towards consumer discretionary with about one-fourth of the portfolio, closely followed by industrials and financials with 19% share each.

Given its small cap bias, EWUS is expected to outperform the broader market in the ongoing economic recovery (read: 3 Small Cap ETFs Leading the Market Higher). The fund gained more than 20% in the year-to-date time frame.

This article is brought to you courtesy of Eric Dutram.

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