Sterling ETFs set for volatility as triggering of Article 50 nears

Mar 15th, 2017 | By | Category: Alternatives / Multi-Asset

Dive deeper into ESG & Impact investing at our upcoming breakfast briefing on Wednesday 28th March 2018 at The South Place Hotel, London, with presentations from Equileap, FTSE Russell, MSCI and UBS - REGISTER NOW

Investors in currency ETFs with sterling exposure may need to brace themselves for increased volatility following confirmation that UK Prime Minister Theresa May will trigger Article 50 (the official process whereby Britain begins to leave the EU) this month and Scotland’s First Minister Nicola Sturgeon is preparing for a second referendum on Scottish independence.

Sterling ETFs set for volatility as triggering of Article 50 nears

Theresa May has confirmed Article 50 will be triggered before the end of March.

Sterling had shown resilience in recent weeks due to positive domestic economic data and a more coherent message on Brexit from the UK’s Prime Minister, but that period may be short-lived.

Fears that the European Union will take a hard-line position when it comes to negotiating the UK’s departure have sent the country’s Purchasing Managers Indices for construction, manufacturing and services – all indicators of economic health – down towards the 50 mark, signalling a contraction of these sectors.

Sterling also dropped on news that Sturgeon would propose a vote in Scotland’s parliament, the success of which may begin to pave the way for a second referendum on Scottish independence. However, the currency rebounded upon the release of a YouGov poll which indicated that 57% of Scots are opposed to independence – a slightly larger majority than that which ended the first referendum.

In light of current uncertainty, investors could choose currency ETFs to express tactical views or could place their capital in currency-hedged ETFs to mitigate the adverse impact of FX fluctuations on their portfolio.

If investors opt for the former, they should note that analysts with a bullish long-term view on sterling’s relative value are hard to find; it is easier to make an optimistic case for the dollar and the euro and to express hope that sterling will simply hold its current value throughout 2017.

The sterling / US dollar exchange rate has sunk from 1.47 $/£ in June 2016, the time of the Brexit referendum, to around 1.20 $/£ today, while the sterling/euro exchange has fallen 1.30 €/£ to 1.14 €/£ over the same period.

Although the triggering of Article 50, set for the last week of March, may cause minimal impact to sterling, the currency might feel a more dramatic effect due to the response of the EU members in the days afterwards. This is because the legal process to leave the EU has been well documented, but the impact of the departure and responses from remaining member states are not known and therefore cannot be reliably priced in.

Analysts say that sterling might bounce in the two years between Article 50 and the actual departure of the UK as investors consider the currency cheap and the UK’s gross domestic product is still set to grow this year by 2%.

But there are other moving parts which will likely affect the currency’s relative value during this period, including rate rises in the US and the French Presidential election.

The risks of Brexit remain unchartered territory, such as the impact on investment in the UK and how the currency’s decline will affect small businesses. Large-cap UK equity indices such as the FTSE 100 have benefitted from the GBP decline as many large companies have become more competitive in overseas markets – the iShares Core FTSE 100 UCITS ETF (LON: ISF) is up more than 25% over one year.

For ETFs that express a direct, tactical play on currencies, ETF Securities offers a wide range of passive funds that go long and short on G10 currency pairs, including sterling, euro and the dollar. For sophisticated investors who seek inverse and leveraged exposures, Boost ETP provides currency funds which magnify returns by four and five times.

Those European investors who want more strategic currency hedging, WisdomTree has a range of ETFs which employ a rules-based analysis of fundamental factors which affect exchange rates to determine how much hedging is necessary given current market conditions. UBS and Lyxor also offer funds that hedge out FX exposure of UK equities.

Tags: , , , , , , , , , ,

Leave a Comment