UK election result impacts equity and currency ETFs

Jun 9th, 2017 | By | Category: ETF and Index News

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Exchange-traded funds linked to the UK are feeling the impact of the surprise general election result which saw the Conservatives fail to secure the 326 seats needed for an absolute outright majority.

UK election result impacts equity and currency ETFs

The British pound fell 2% against the dollar and as much as 2.3% against the euro as exit polls predicted a hung parliament in the UK general election.

The first signs of trouble for the Tories came with the release of the exit poll shortly after voting officially closed which predicted that, although Conservatives would remain the largest party, leader Theresa May would need to rely on the support of other parties to command a workable majority.

The announcement spooked markets and led to the pound diving by 2% against the dollar and as much as 2.3% against the euro in Asian trading. Despite rallying in the early hours of Friday morning, sterling is down around 1.8% against the dollar and 1.5% against the euro.

Michael Metcalfe, global head of macro strategy at State Street Global Markets, part of the asset management group behind the SPDR ETFs line-up, commented: “Markets were poorly prepared for this surprise result in the UK. While the dramatic narrowing in polls prior to the vote had introduced an element of doubt, an outright Conservative victory was still the base-case scenario for most. It is a shock that markets were not well prepared for, and in response sterling is likely to remain under pressure.”

Viktor Nossek, director of research in Europe at ETF issuer WisdomTree, said: “This is a real shock for markets which had, like the polls suggested, expected the Conservatives to increase their majority. There will be no notion of strong and stable in currency markets after this vote. The pound has tumbled overnight, and this could be just the start, with volatility likely to remain elevated. Indeed, as the ramifications of this vote become clearer, the falls against the US dollar and other currencies could become more pronounced.”

Investors looking to play the sterling theme can gain exposure to the performance of the currency against the euro or the dollar, either long or short, through a range of FX ETFs from various providers, such as ETF Securities. For those wishing to express a leveraged tactical view that sterling will continue to decline against its major currency trading partners, the firm offers 3x and 5x short GBP ETFs.

While the 10-year UK government bond yield initially rose in response to the election forecast, indicating the higher risk premium associated with UK assets, it has since fallen below its pre-election level and is trading around 1.01%. The fall in yields, a positive for investors in UK Gilt ETFs such as the SPDR Barclays UK Gilt UCITS ETF (LON: GLTY), is likely in response to investors looking to take some risk off the table and may reflect expectations of a slower path for interest rate increases.

Bill Street, head of investment for EMEA at State Street Global Advisors, said: “The initial risk-off market reaction will drive gilt yields sharply lower. Over the short term, we believe that this move will continue as political uncertainty reigns supreme. However, the emergence of a Labour-led coalition could trigger a bearish environment for gilt yields. As the market prices in campaign promises of fiscal stimulus and a softer-Brexit, we believe that gilt yields could be on course for a sustained upward move over the medium term.”

The result has thus far been bullish for large cap UK equity ETFs, such as the iShares Core FTSE 100 UCITS ETF (LON: ISF) and the Vanguard FTSE 100 UCITS ETF (LON: VUKE), which posted gains of around 1.1% at market open. Companies within the FTSE 100 are more global in nature and are protected somewhat from domestic events in the UK. The devaluation of sterling improves the bottom line of these corporations which earn a significant proportion of their revenue in overseas markets.

It was a different story for UK mid-caps, however, known as a better barometer of the health of the UK’s domestic economy, as the FTSE 250 Index quickly fell by 1% at market open. ETFs such as the iShares FTSE 250 UCITS ETF (LON: MIDD) were negatively impacted by the move but have since regained about half these losses.

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