Thursday's vote in Great Britain didn't go the way that many had hoped, and the prospects of a U.K. exit from the European Union have hit global markets hard. U.K. stocks have gotten hit hard, and because of the British pound's plunge, dollar-denominated U.K.-stock ETFs are down more than 11% at midday Friday. But some of the hardest-hit ETFs are actually outside Great Britain, showing the collateral damage that the vote is doing across the globe.
European ETFs fear an economic collapse
Many single-country ETFs in Europe have fallen more sharply than markets in the U.K., in large part because the economies of certain individual companies rely more heavily on the European Union than others. The iShares MSCI Spain ETF (NYSEMKT:EWP) is down 15%, while the iShares MSCI Italy ETF (NYSEMKT:EWI) fell 14% at midday. ETFs for other countries, including Ireland, Sweden, and France, were also down double-digit percentages.
European single-country ETFs are struggling in part because the euro has lost ground against the U.S. dollar. Also, the extent to which the European Union has caused economic linkages across the continent means that single nations are no longer insulated from economic disruptions in other parts of the region. In particular, Italy and Spain have relied on the EU to help them reduce their sovereign borrowing costs to finance government operations, and many investors fear that the Brexit decision will bring back the same conditions that created an economic crisis in Europe several years ago.
Currency ETFs get slammed
Many investors don't follow foreign exchange markets all that closely, but the Brexit vote has had a dramatic impact on currency markets. The CurrencyShares British Pound ETF (NYSEMKT:FXB) is down almost 9% at midday Friday, and the corresponding CurrencyShares Euro ETF (NYSEMKT:FXE) has fallen a more modest 2.5%.
The value of the British pound fell below $1.35 for the first time in three decades, and the Bank of England has had to reassure market participants that it will take all necessary steps to make sure that it can maintain monetary and financial stability amid the market turbulence. If the U.K. loses its status as a primary financial hub for Europe as a result of the vote, then investors might dramatically reduce their holdings of the British currency. The resulting shock to the economic system could have further second-order effects that might threaten to cascade into a full-blown crisis if central banks can't stop it.
The anti-volatility ETF gets a shock to the system
Volatility ETFs have given investors a way to profit from unexpected events like the Brexit vote to leave the EU, but they've generally been bad performers overall. Instead, anti-volatility ETFs like the VelocityShares Daily Inverse VIX Short-Term ETN (NASDAQ: XIV) have been long-term winners during the long bull market, with the fund rising more than fivefold from 2011 to mid-2015.
Today, though being unpositioned for volatility, has proven to be the VelocityShares inverse fund's downfall. A surge in the CBOE Volatility Index has sent the inverse fund's shares down 22%, returning the share price to early 2013 levels and wiping out more of long-term investors' gains. The fund's performance over the past year shows that even relatively flat stock market environments can lead to losses, but the real threat comes from days like today and their huge impact on future returns.
Many of these tumbling ETFs might well rebound in the days to come if fears about the impact of the Brexit on financial markets globally turn out to be overblown. For today, though, investors in these and similar funds need to be mentally prepared to accept the losses they're suffering.