Tread Carefully in Bank-Heavy U.K. Funds

The U.K. might be the most comfortable foreign country for U.S. investors.

But like the U.S., the U.K. has had to endure market cycles that investors should be wary of.

The current global slowdown started in the financial sector. The distorted yield curve warned well in advance that trouble was coming, and anyone heeding that warning has missed some of this pain.

The yield curve inverts every so often, and for my money, that signals trouble. When this occurs I want to reduce financial exposure, which requires looking under the hood of any broad-based products you own.

Consider iShares UK Index Fund(EWU).

EWU currently has a 23% weight to financials, down from 29%, according to my best estimate. U.K. banks have generally felt the same pain as those in the U.S., creating a big drag in the U.K. market. This is not unusual given that many markets have a large weighting in financials, a drawback for many country funds.

Given the heavy weighting in financials, EWU has become a less than ideal way for investors to access the U.K.

Just as in the U.S., staples and health care are often good places to overweight in a bear market decline. For example, see the chart below of EWU against GlaxoSmithkline(GSK) (GSK).

Click here for larger image.

Despite a rough go for GSK in January, when the correlation was quite high, GSK has done what an investor might have hoped for over the course of the entire year, offering investors a good place to hide during the current downtrend.