Global investors are distinguishing between the UK and the rest of Europe as part of a fundamental reassessment of what investing in the region means, reflecting growing enthusiasm for Europe’s broad economic prospects and nervousness about thorny and possibly protracted Brexit negotiations.
That has meant the forceful emergence this year of “Europe ex-UK” as an investment class, as offshore investors actively seek to avoid lumping British stocks into any Europe-bound investments.
The UK has been an intrinsic part of the European investment process for decades, in no small part because of London’s role as the regional financial hub and because of deep links engendered by free trade and free movement of goods and people across the EU.
With Brexit, and the future of many of those links uncertain, there is a growing realization that the UK and EU financial markets will develop their own nuances and drivers which require old assumptions to be challenged.
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Data from Lipper – a Thomson Reuters company – on year-to-date flows in and out of exchange traded funds (ETF), a proxy for broader investments, shows that this is well under way.
ETFs that track European stocks excluding the UK are the ones seeing the strongest demand and the largest of these, the iShares MSCI Eurozone ETF, has seen a net $3.9 billion pumped into it this year.
Meanwhile, regional ETFs which include UK stocks have bled money, suggesting investors looking only for European exposure are actively seeking to avoid British stocks.
“Europe ex-UK” is not a new investment concept, and the size and scope of products available to investors is small compared to those available on a pan-European basis.
According to Lipper, there are more than 1,800 mutual funds globally that invest in pan-European stocks and combined they manage more than $250 billion.
The number of funds that invest in European stocks excluding those listed in the UK, meanwhile, total a little more than 150 and they manage a combined $50 billion.
That said, the decoupling has been noticeable since Britain voted to leave the EU in 2016.
“The two regions have been separate but that has been accentuated by Brexit,” said Stephen Mitchell, a portfolio manager who runs a global equities fund at Jupiter Asset Management.
“American investors left the UK in the two weeks after Brexit – by July 2016 they were gone. The uncertainty of Brexit has kept them out,” Mitchell said, adding that they have returned to Europe but not the UK.
“That’s probably going to continue to be the case for the time being.”
After a year of second-guessing political outcomes and getting whipsawed by market moves in the aftermath of Brexit, the U.S. presidential election and the Italian constitutional referendum, investors have shied away from trading based on opinion polls and have sharpened focus on fundamentals.
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Here, the divergences between the UK and Europe are getting starker.
Political risks facing the euro zone eased following the French election, whereas in the UK an election that was considered a foregone conclusion until last week now looks less certain.
Moreover, the economic outlook in the UK is clouded by concerns around whether consumer spending is sustainable, while in the EU things appear to be more upbeat.
“This is one area where the contrast with continental Europe is very strong,” said Isabelle Mateos y Lago, Chief Market Strategist at the world’s largest asset manager BlackRock.
“It’s hard to quantify how serious, but we’ve already seen that since the Brexit referendum, UK consumers have been drawing down their savings to an all-time low savings rate,” Mateos y Lago said.
UK LIKE JAPAN?
The UK does remain a key market for global investors and offers them access to major commodity producers such as Rio Tinto and Royal Dutch Shell, food and beverage bellwethers Diageo and Unilever and emerging market-focused banking giants like HSBC that are not on the continent.
Also, companies in the euro zone rely heavily on the UK as a market. For example, about 10 percent of the revenue of top euro zone companies comes directly from the UK, according to data from MSCI, meaning investors will still have to closely monitor the health of the UK.
Some say Asia might offer a template for how the investment landscape might evolve.
“With Brexit the UK is going to be a bit differentiated. A bit like Japan. It’s part of Asia but the difference is material enough to attract separate research,” said Colin McLean, managing director at SVM Asset Management.
A big reason for this is that Japan and the rest of Asia can, and often do move independently of each other.
John Cryan, the British chief executive of Deutsche Bank, alluded to something similar playing out in Europe, as Brexit negotiations loom.
“…for the medium term, I think the Euro 27 does relatively well,” Cryan said at a financial conference hosted by his bank in New York last week.
“The U.K. though, I think is only just coming to terms with the complexity of what a Brexit entails.”
For investors, also grappling with these complexities, a Europe ex-UK could make life a little easier.