On Friday, June 24, Britain voted to leave the European Union (EU). This was huge news for a number of reasons. Britain was one of the largest economies in the EU, and the global markets had widely expected the remain camp to prevail. The Dow Jones Industrial Average (DJIA) rose more than 200 points the day before the vote, which implied that the market was pricing in for the remain vote to win. The outcome for leaving was not priced in by the market, which is why the DJIA fell 500 points at the open on Friday.
That being said, not everything was in the red Friday. Defensive sectors within the S&P 500, including utilities, real estate investment trusts, and consumer staples stocks, were up on a huge down day. Other noteworthy outperformers included gold, US bonds, and the Japanese yen. These sectors and asset classes are how investors should play Brexit, which can be done through exchange-traded funds.
What Just Happened?
In the referendum, Britain voted 51.8% to 48.2% in favor of leaving the European Union. The EU is a group of 28 member nations that agreed to establish rules as a group that superseded any individual nation’s own rules. These rules mostly pertained to trade and commerce within Europe. At a basic level, the agreement is designed to make each country better off as a whole than they would be as individual nations. The EU helped facilitate the flow of trade, capital, workers, and goods throughout the EU.
Now that Britain has voted to leave the EU, it has major implications, perhaps more so for the EU than for Britain. Britain is a strong, diversified economy. The leave camp widely believed that the EU needed Britain far more than Britain needed the EU. The outcome of the referendum shook the markets for two reasons: the EU, a major trading partner with the U.S., will be weakened without Britain. In addition, the markets hate uncertainty, and now there will be a great deal of uncertainty over how Britain will proceed and whether any additional nations in the EU will pursue the same course.
How to Play Brexit With ETFs
ETFs were in high demand on Friday after the vote results were tallied. According to Eric Balchunas Senior ETF Analyst for Bloomberg Intelligence, as of noon EDT, ETFs accounted for over 50% of equity volume on Friday — $87 billion of $164 billion total.
Now that Britain has officially voted to leave the EU, investors can prepare their portfolios by getting more defensive. Focus on safe haven asset classes, sectors of the market that are more defensive in nature, pay dividends to protect against falling markets, and in particular, look for industries that are not heavily exposed to Europe. Two major ETFs that significantly outperformed Friday as the markets were crashing were Utilities Select Sector SPDR ETF (XLU ) and SPDR Gold ETF (GLD ).
The utility sector is sufficiently insulated against international geopolitical risk because most utilities conduct their business operations in the United States. Plus, the holdings within the XLU fund are modestly valued and provide significant dividend yields, which are both meaningful margins of safety. For example, XLU holds an average P/E multiple of 18.22 and a 3.2% dividend yield.
And XLU is much less volatile than the S&P 500. The XLU fund has a beta value of 0.23, meaning that for every 1% move down in the S&P 500, XLU is expected to decline just 0.23%. This can help protect investors against the potential for further downside.
Separately, GLD is a fund that reflects the price movement of gold bullion. In times of geopolitical stress like this, gold is often a major beneficiary because it is seen as a safe haven. GLD was up 5% in early trading on Friday, as investors flocked to the risk-off assets like gold.
Other areas that investors should consider are U.S. government bonds. After the Brexit vote, the yield on the 10-year U.S. Treasury Bond dropped nearly 20 basis points. This caused bond prices to rally, since bond prices and yields are inversely related. An ETF that tracks long-term U.S. government bonds is iShares 20 Year Treasury Bond ETF (TLT ), which was up 3% in early trading. Among global currencies, the Japanese yen was a big winner, as money poured out of Europe. The CurrencyShares Japanese Yen ETF (FXY ) was also up more than 3% Friday.
The Bottom Line
Given the uncertainty in the markets following the EU membership vote, markets have declined across the board. However, there are still opportunities for safe haven investments that outperformed the overall market. The easiest way investors can gain exposure to these assets is through ETFs.