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Play the Rising Pound with These ETFs

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The year 2014 has so far been lucky for the British currency with the sterling emerging as one of the strong performers among the 10 developed-market currencies tracked by Bloomberg. The British pound surged to a four-and-half year high against the dollar, gaining double digits over the past one year.

Will This Trend Continue?

The currency continues to strengthen as strong economic growth and a flurry of mergers and acquisitions activities boost demand for the currency.

This is especially true given that the U.S. largest drug maker Pfizer (PFE) again proposed to acquire the second-largest British drug maker AstraZeneca (AZN) for £58.8 billion ($98.7 billion). If successful, it would be the biggest takeover of a U.K. firm by a foreign company, suggesting more money inflows into the economy resulting in a surge in the British currency (read: Pharma ETFs: A Safe Haven from the Biotech Stock Slump?).

The British economy showed continued recovery in the first quarter despite floods and bad weather. The economic growth accelerated to 0.8% from 0.7% in the last quarter of 2013 but slightly fell short of analyst estimate of 0.9%. Annual GDP growth rose 3.1% year over year, representing the strongest growth in more than six years.

Further, United Kingdom is expected to outperform the major advanced economies this year with growth of 2.9%, as per International Monetary Fund. This suggests higher confidence in the country’s growth prospects going forward. This could be easily justified given the positive recent consumer survey for the country. The YouGov/CEBR consumer confidence index for April rose to the highest level since August 2007.

Moreover, a strengthening housing market and improving job market are bolstering growth in the economy and improving the sterling sentiment. Notably, unemployment in the country dropped to the lowest level in five years to 6.9% in February, and has reached below Bank of England’s threshold of 7%. This has raised the prospect of an interest rate hike sooner than expected in Britain, further supporting the currency upswing.

Given the strengthening economic fundamentals, the bullish trend in the pound sterling is expected to continue at least for the short term. Investors seeking to ride the surge in British pound could consider any of the following ETFs (see: all the Currency ETFs here):

CurrencyShares British Pound Sterling Trust ((FXB - Free Report) )

This fund appears a great way to play the future rise in the sterling pound relative to the U.S. dollar. It tracks the movement of the British pound sterling relative to the USD, net of the Trust expenses, which are expected to be paid from the interest earned on the deposited pounds.

The product is illiquid, trading in volume of less than 33,000 shares a day, suggesting additional cost in the form of wide bid/ask spread beyond the expense ratio of 0.40%. The ETF has amassed $82.6 million in its asset base and has gained 8.50% over the past year.

iPath GBP/USD Exchange Rate ETN ()

Investors confident about appreciation of GBP against USD can also consider this product. This ETN seeks to track the performance of the EUR/USD exchange rate. The product not only provides a core investment opportunity in the currency space but also enables investors holding a well-diversified portfolio, to hedge their position against foreign exchange fluctuation (read: Where Will Global Currency ETFs Go in 2014?).

The note charges 40 bps in annual fees from investors. GBB has failed to attract investors with just $2.7 million in its asset base and 767 shares in average daily volume. This raises the total cost of trading for this unpopular product. The ETN has added about 10.7% in the trailing one-year period.

Bottom Line

Though short-term outlook for these products seem encouraging, the long-term outlook remains negative. This is particularly true as both products have a Zacks ETF Rank of 5 or ‘Strong Sell’ rating, suggesting that some pain could be in store for this currency or U.S. dollar might move northward (read: Time to Bet on the British ETF?).

However, short-term investors could make a play on the surge in British pound by going long in the above two unleveraged products given encouraging economic growth and rising sentiments for the British pound sterling.

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