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As Britain begins divorcing itself from the European Union, investing in the EU requires different strategies, and acceptance of risk, experts say.

BEN STANSALL/AFP/Getty Images

As Britain begins the thorny task of divorcing itself from the European Union, and economic ties are undone and reconfigured, investors may be wondering how to respond.

There are several exchange-traded funds for those looking for opportunity in the Brexit process, but London-based City Index market analyst Ken Odeluga (below) warns the path is fraught with risk.

City Index's Ken Odeluga: The data suggest economic growth is sluggish but nevertheless 'definitely happening.' City Index City Index

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(Courtesy of City Index)

"At the moment we're not hearing a great deal about the opportunities but they are bound to be there. There is ample room for caution," he says.

That skittishness is rooted in the dramatic global market sell-off last June when Britain shocked the world by voting to leave the EU in a national referendum. The resulting uncertainty cooled the economies in Britain and mainland Europe.

Mr. Odeluga says as Brexit negotiations get set to begin, there are signs the pace of economic growth in Europe is picking up. "The data may suggest that it is happening at a very sluggish rate but nevertheless it is definitely happening now."

Currencies

British and European equity markets have since regained lost ground from the referendum shocker, but still lag behind the developed world. The British pound and euro have also fallen against other G10 currencies – and that is where Mr. Odeluga says opportunity lies for Canadian investors.

"The impact of that economic weakness has been to suppress corporate earnings growth and stock market values as well," he says. "If you cut all that with a relatively weak currency in the U.K. and Europe it's a beneficent circle for the investor overseas."

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He says the best equity values are currently in consumer goods and the food and beverage sector.

Resources

European resource stocks have seen triple-digit percentage rises since commodities started bouncing back last year, but he says resource companies are worth consideration because they have increased their value by trimming costs through asset sales and debt reduction.

"Resource companies became highly efficient and highly cash generative – not because they were highly profitable, but because they were just being ruthlessly efficient," he says.

Banks

However, economic growth in Europe has not been strong enough to coax the European Central Bank to hike interest rates. Mr. Odeluga says low rates make investing in big European banks "problematic."

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"Low rates are likely to stay. If that's the case, bank shares stand to hit a ceiling in their recovery at some point," he says.

Countries

Of the 28 member states in the EU, Germany has been the best market performer and Mr. Odeluga considers it the most stable country in which to invest. "There are some structural benefits in Germany. It has a long history of being the strongest economy in the eurozone. It's also a manufacturing powerhouse and benefits from its centralized geographic location."

Junior EU member countries known as the PIGS – Portugal, Italy, Greece and Spain – are still reeling from the 2008 financial collapse, but are expected to have the most upside potential for investors willing to take more risk.

"I wouldn't write them off. You're looking at recovery plays for Portugal, Spain and even Italy, which is beset by additional challenges within its banking sector," says Mr. Odeluga.

Different approaches

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Here are some funds for investors to consider.

"We have a very positive, constructive view on Europe," says Lindsay Patrick, who manages global ETF distribution for RBC Dominion Securities Inc.

"We think a lot of negative news is priced into the European equity market right now," she says. "You have cheaper valuations, higher dividend yields and perhaps even better earnings expectations."

For investors who want broad exposure to Britain and Europe, she suggests two ETFs available on the Canadian market: iShares MSCI Europe IMI Index, which holds nearly 1,400 stocks in 15 countries, and the Vanguard FTSE Developed Europe All Cap Index, with 1,229 companies across Europe.

Each has a version that is not hedged to the Canadian dollar, like many of the foreign ETFs sold on the Canadian market. Ms. Patrick says whether to hedge currencies or not is up to the individual.

"The only consideration is your view on the Canadian dollar. If you're buying them for a long-term retirement plan and your retirement expenses are going to be in Canadian dollars, you would like to hedge it."

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She also says investors need to decide whether they want a European ETF that includes Britain.

The only European sector ETF available in Canada is First Asset European Bank ETF. It holds financial companies across Europe, including Britain, but is not hedged.

And iShares provides individual U.S.-listed ETFs for each country in the EU. They are not Canadian-dollar hedged.

Annual fees for index ETFs are usually under one-quarter of a per cent of assets invested, but they can be higher for more actively managed ETFs termed "smart beta."

One smart-beta ETF is BMO MSCI Europe High Quality. It favours companies based on earnings, value and dividend growth. "It has a good dividend yield and as a result tends to be in lower-risk sectors and countries," she says. "This would be more for an investor who is a little bit nervous about expanding into international equities and wants a lower-risk way to get into it."

Another smart-beta ETF that can also generate income is the RBC Quant European Dividend Leader ETF. "It scours the European market for the highest sustainable dividend yield," says Ms. Patrick. It also has an unhedged version.

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Her advice for anyone looking to profit from Brexit through ETFs: Know what you're buying. "You need to look inside the ETF to be sure what exposure you're getting," she says. "Make sure you look under the hood."

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