British Economy: UK ETF Investing 101 (EWU, EWUS, FKU)

Eric Dutram: Fiscal 2011 was a challenging year for the U.S and the global economy. While the Euro zone debt crisis seems to be a never-ending phenomenon, recent developments from the troubled Euro zone have revived the probability of economic contagion spreading to other economies as well, sparking a fresh crisis.

Greece, the problem child of the Euro zone crisis, has been in the headlines again for all the wrong reasons. The probability of a Greek exit from the 17 nation currency block is certainly in the cards. This could spell disaster for the global economy as it may cause a run on the banks for most European financial institutions that have heavy Greece exposure, potentially placing the entire banking system in harm’s way. (see Spain ETF Slumps On Weak Bond Auction)

While these recent developments have mostly plagued the minds of institutional as well as retail investors, many still seek a European exposure beyond the euro zone. One such destination for the investors is the United Kingdom.

By no means is the U.K immune to the ongoing crisis in their neighborhood, as the country still has exposure to the region and does a great deal of business with euro zone members. However, they are not directly within the Eurozone and have an independent currency, allowing them more flexibility in difficult times (read Three European ETFs That Have Held Their Ground).

British Economy In Focus

The U.K economy has also had its share of troubles. Technically speaking, the economy is officially in recession, as the GDP numbers have had negative growth for the last two preceding quarters.

Part of the reason for this is that the country has embarked on an austerity campaign in order to help reign in surging budget deficits.  This was seen as necessary to reverse one of the worst budget situations in Europe, only surpassed by a few PIIGS nations.

While this slash in spending has undoubtedly curtailed growth, it has probably also shifted the focus away from the UK, allow the nation and its markets to avoid the worst of the crisis (read Pain In The Spain ETF (EWP) Continues).

UK Market Performance

Following a gain of 10%, the U.K. broader market index, the FTSE 100, slumped 6.5% last fiscal on a year-on-year basis. However, this fall in the U.K. stock market was not as bad as most of its European counterparts who had an even tougher time thanks to the weakness of the euro (see Is the Italy ETF (EWI) Next?).

Despite this gloom, all is not lost for the U.K. stock markets. The major downturn in the broader markets has led to less expensive current market valuations and more robust dividend yields.

Furthermore, given the current dynamics, the likes of a round of quantitative easing (QE) also cannot be ruled out. This is bound to put downward pressure on interest rates to the extent that the 10-year Government Bond rates are bound to fall.

This coupled with the increasing dividend yields, would make the equity markets an attractive proposition by comparison. This is especially true for investors seeking to maintain some level of European exposure, but are still concerned about the euro zone markets at this point in the market cycle.

In these troubled times, a well diversified basket approach to investing is the appropriate choice for investors, especially in risky markets such as the U.K. Therefore an ETF technique may be the best way to play the U.K recovery. (see For Europe ETFs, It Is Hard To Beat Switzerland)

For these investors, any of the following three British ETFs could make for an interesting choice:

iShares MSCI United Kingdom ETF (NYSEARCA:EWU)

With total assets of about $1.30 billion and average daily volume of 1,733,320 shares, EWU is one of the biggest and most liquid ETFs in this space. It provides investors with exposure to companies across the spectrum of market capitalization and thereby capturing the essence of the U.K stock markets.

The fund had its inception in March 1996 and tracks the MSCI United Kingdom Index. The capitalization weighted index holds some of the biggest names in the U.K. equity markets such as HSBC Holdings PLC, Vodafone Group PLC, BP PLC and Royal Dutch Shell PLC.

The ETF has seen tough times in the recent past and has slumped -9.46% in the last one year. Unfavorable economic data from U.K.’s neighbors and negative macroeconomic trends were pretty much the cause for the underperformance of the fund. EWU holds106 securities presently and allocates around 46% of its total assets in the top 10 holdings. The ETF charges 52 basis points in fees and expenses to investors.

iShares MSCI United Kingdom Small Cap (BATS:EWUS)

EWUS is yet another product tapping the U.K markets. It was launched in January of 2012 and tracks, before expenses, price and yield performance of the MSCI United Kingdom Small Cap Index. The index measures equity performance of small cap companies whose market capitalization represents the bottom 14% of the U.K equity markets (read Guide to Small Cap Emerging Market ETFs).

The fund holds 269 securities currently and has total assets of $2.55 million. EWUS allocates its assets uniformly across all securities of the index ensuring that concentration risk is nearly diversified away.

It holds 267 securities at present, allocating 12.90% of its total assets in the top 10 holdings. The ETF can be a decisive tool for investors looking for European exposure for their portfolio and at the same time allow them to play a U.K. recovery as well.

Unfortunately the expense ratio for the fund stands high at 59 basis points. Going forward, the product is expected to perform well, given its popularity and as indicated by the inflow in its asset base in just three months. Given its small cap bias, the ETF is expected to outperform the broader markets in case of an economic recovery, as small caps outperform their large and mid cap counterparts at times of recovery.

First Trust United Kingdom AlphaDEX (NYSEARCA:FKU)

Launched in February of 2012, FKU is the latest addition to ETFs tracking the U.K. stock markets. It tracks the Defined United Kingdom Index and employs the AlphaDEX methodology of stock selection.

According to this methodology, stocks are chosen from the S&P United Kingdom BMI universe and ranked on the basis of various fundamental growth and value factors.

The higher ranked stocks receive a bigger weighting while the lowest rated securities are excluded entirely. The ETF seeks to outperform the underlying index, thereby generating a positive ‘alpha.’

On the down side, investors are charged a hefty premium of 80 basis points in fees on account of this unique methodology. In just about three months since inception, the ETF has managed total assets worth $4.27 million and has an average daily volume of about 3,121 shares. This suggests that the fund has failed to gain a great deal of popularity but it is still quite new overall (also see Norway ETFs for Safer European Play).

The British ETF had started off well after its debut. However, with the worsening situation in Eurozone and the U.K; the fund appears to have lost its way. Nevertheless, even in these tough times the fund has shown resilience, mainly thanks to its unique methodology and more ‘active’ approach.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 DaysClick to get this free report >>

Written By Eric Dutram From Zacks Investment Research

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.

Leave a Reply

Your email address will not be published. Required fields are marked *