Market Overview

Pound Punishment Is Perfect For These ETFs

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Pound Punishment Is Perfect For These ETFs

Speculation and confirmation of Brexit has, predictably, made the British pound this year's worst-performing developed market currency. Just look at the CurrencyShares British Pound Sterling Trust (Guggenheim CurrencyShares British (NYSE: FXB)), which tracks the sterling against U.S. dollars.

Across The Pond ETFs

That ETF is down 12.6 percent year-to-date, and, in a sign that things are not getting better for sterling, FXB is lower by 3.2 percent over the past month and resides near new lows. Although it has traded higher post-Brexit, the iShares MSCI United Kingdom ETF (iShares Trust (NYSE: EWU)), the largest U.K. ETF trading in the United States, paints the picture of the currency risk associated with international investments investors often ignore.

Related Link: The Bank Of England's Rate Cut Could Boost U.S. Equities

EWU is down 2.4 percent year-to-date, a showing that is not nearly as bad as sterling itself, but still one that should serve as a reminder that, because EWU is not currency hedged, it is vulnerable to pound weakness.

On the other hand, the WisdomTree United Kingdom Hedged Equity Fund (WisdomTree Trust (NASDAQ: DXPS)) and the Deutsche X-Trackers MSCI United Kingdom Hedged Equity ETF (DBX ETF Trust (NYSE: DBUK)), which hedge sterling movements against the dollar, are up 15.5 percent and 10.2 percent, respectively. That says investors expect some marquee FTSE 100 names to benefit from pound weakness. It also says investors looking to nibble at U.K. stocks right now should consider currency hedged strategies.

Investor Action, Sentiment

Data suggest bearish traders targeting U.K. stocks are focusing more domestically-driven names, which makes sense as exporters benefit from the slumping pound.

“The underperformance of domestically exposed firms has not gone unnoticed from short sellers as the domestically exposed basket of shares across both strategies has seen a large rise in shorting activity in the six weeks since the referendum. Exporters on the other hand have seen little in the way of shorting activity with short sellers covering their positions among the firms that make up the strong momentum undervalued basket,” said Markit in a recent note.

Although it has a 15.6 percent exposure to domestically-driven financial services names, DXPS is sufficiently exposed to the exporters theme as consumer staples, energy and healthcare names combine for nearly 48 percent of the ETF's weight. On the FTSE 100, companies from those sectors frequently derive, on average, half their revenue from outside the U.K., with much of it coming from North America.

“This surge in demand to short domestically exposed UK firms now means that short sellers were more active in the FTSE 350 index in the weeks following the referendum than at any time in the last two years,” added Markit.

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