EWA iShares MSCI Australia

With a robust record of strong growth rates, above par capital market performance and strong macro-economic fundamentals even in times of economic uncertainties, the economy “down under”, Australia, is certainly one of the most popular international destinations for investors.  

The economy of Australia is characterized by strong per capita income (one of the highest in the world), low unemployment, low budget deficit and high levels of economic freedom. In fact, Australia is ranked third in terms of economic freedom (behind Hong Kong and Singapore) and has an economic freedom score of 83.1 , not only making the region one of the most economically free countries in the Asia-Pacific region, but also the entire world (read Developed Asia Pacific ETF Investing 101).

The worsening situation in the euro zone and the slowdown in the U.S. economy characterized by weak jobs data have many direct as well as institutional investors shifting focus from the developed western economies to the Asia-Pacific region, especially Australia.

Of course adding to the flavor is the nation’s proximity to most of the industrialized Asia-Pacific region like New Zealand, Singapore, Japan, and South Korea, abundance of natural resources, favorable labor laws and a well diversified economy (see The Five Minute Guide to New Zealand ETF Investing).

The Aussie economy is also major exporter of commodities from the agricultural sector, energy products as well as industrial minerals. However, the economy has been hit hard by falling commodity prices worldwide. Also adding to its woes is the generic slowdown and continuous decrease in industrial production in the world’s second largest economy and one of its largest trading partners, — China.

In fact, the Reserve Bank of Australia’s (RBA) Commodity Price Index had increased by 1.27% for the month of July 2012 in terms of SDR (special drawing rights) on a month-on-month basis. This was mainly due to a rise in prices of wheat and oil.

However, the index has slumped by 0.84% on a year-till-date basis and by 9.75% over the past year, given the subdued industrial consumption from the major industrialized nations. Currently the absolute value of the index stands at 135.2 in terms of SDR for the month of July 2012.

Despite this, the Australian economy had reported a trade surplus of AUD 9 million for the month of June 2012 after a series of reported trade deficits over the preceding months. Despite the gloomy situation in the global economic environment, the economy expanded at an impressive rate of 1.3% for the first quarter of fiscal 2011 over the previous quarter. However, on a year-on-year basis the GDP growth posted was 4.3% over the same quarter last fiscal year.

The present unemployment rate in the economy stands at 5.2% for the month of July 2012, compared to 8.3% for the U.S for the same time period. Presently, the benchmark interest rate is 3.50% and the Consumer Price Index has jumped by 10 basis points for the March 2012 quarter. The Reserve Bank of Australia (RBA) had slashed interest rates four times since November 2011 onwards (see Beyond Corn: Three Commodity ETFs Surging this Summer).

The rate cuts add up to 1.25% cumulative. From its three-year high at 4.75%, the interest rates have come down to 3.50% on account of these four subsequent rate cuts. Still, thanks to the relatively high interest rate, the RBA will have a number of policy options going forward, giving it more room than many of its counterparts in the Western world.

Stock Market Performance

Like most of the developed nation’s stock markets, the Australian benchmark stock market index (the ASX 200) also had a mixed year in fiscal 2012. The index is up by 4.96% on a year-to-date basis, compared to the S&P 500 returning 11.43%.

The ASX 200 posted positive returns for the 1^st quarter, returning 6.23%, however, this gain has been severely offset by the 2^nd quarter slump of 4.85%. On a one-year basis, the Australian index is down by 5.42%, compared to the S&P 500 8.44% upside.

From a sector perspective, the best performing sectors have been the defensive sectors such as Telecommunications and Healthcare. However, the financial sector has also posted above par performance, given the investor focus for high dividend yielding stocks.

On the contrary, the commodity-centric sectors such as Energy, Materials and Industrials have slumped badly and caused the broader markets to limit their gains (see Buy American with these Three Commodity ETFs).

However, it is prudent to note that the Australian stock market (as represented by the ASX 200 index) has a very low correlation with the S&P 500. In fact, since 2007, the daily correlation between the two indexes has been only 19.16% till date, thereby implying international diversification for American investors.

Given these diversification benefits and the relatively strong position of the nation’s economy, it could be time to consider allocating assets to the nation of Australia. For investors seeking an Australian exposure via basket approach, we highlight a few of the top options in the Australia ETF space, any of which could be great choices for those seeking more exposure to the land down under:

The iShares MSCI Australia ETF (EWA) has a multi cap basket which targets the broad Australian equity market as indicated by the MSCI Australia Index. Launched back in March of 1996, it is one of the oldest and most popular products from the Asia-Pacific equity space that targets the Australian markets. EWA has amassed $2.41 billion in assets under management.

The market capitalization weighting adjusted for float methodology for the index construction causes the ETF to be heavily skewed towards the large cap stocks. Moreover, from the entire basket of securities it selects only 71 stocks which best replicate the performance of the Australian equities.

The ETF charges an expense ratio of 53 basis points, compared to a category average of 0.64%. EWA pays out an impressive 4.74% yield which is largely possible due to its high allocation towards the financial sector (48%).

Nevertheless, a major portion of its portfolio is also allocated to the beaten down commodity based sectors such as Materials (22.71%), Industrials (4.44%) and Energy (6.41%). Also, it weightings are heavily skewed towards its top 10 holdings which account for almost 61% of its total assets.

This explains the returns of -11.55% for the ETF for the one year period as on 30^th June 2012. However, the ETF is up by 4.18% on year-to-date basis after the end of the second quarter and given the recent surge in commodity prices (especially oil and natural gas), the ETF is most likely to continue the uptrend that it has witnessed from the end of 2Q12 onwards (read Natural Gas ETFs: Futures vs. Equities).

The WisdomTree Australia Dividend ETF (AUSE) provides a pure play in the dividend paying income stocks in the Australian equity markets. The ETF follows the WisdomTree Australia Dividend Index. The index selects the ten largest dividend paying companies from each sector based on their market capitalization.

This methodology enables AUSE to gain exposure across a variety of sectors. Of course the weighting of each sector significantly differs, depending on the market value of its component companies.

AUSE being a dividend ETF tracking the Australian market, is largely skewed towards the financial sector (21.73%). This is followed by Consumer Discretionary (20.21%), Industrials (11.43%), Consumer Staples (11.30%) and Materials (10.99%).

AUSE has slumped 8.95% in the second quarter of this fiscal and caused the ETF to wipe out the strong gains it had posted in the first quarter. As a result, AUSE is only up by 2.69% on a year to date basis as on 30^th June 2012 (see more in the Zacks ETF Center).

The ETF has been able to amass an asset base of $66.75 million since its inception in June of 2006. It currently sports a yield of 4.76% and charges an expense ratio of 58 basis points. AUSE has a relatively thin average daily traded volume of 8,139 shares which has led the bid-ask spread ratio to shoot up and increase the total costs for investors.

Nevertheless, the ETF can be an interesting option for investors seeking current income, especially due to its diversified portfolio of dividend paying stocks across the entire spectrum of market capitalization levels without a particular bias towards large caps.

Also, the massive correction in its share prices in the second quarter of this fiscal has caused the ETF to trade at good valuations, indicating strong entry points.

Index IQ Australia Small Cap ETF (KROO) provides investors with a small cap flavor in the Australian equity ETF space. Launched in March of 2012, KROO is one of the latest additions in this segment. Since its inception, KROO has been able to attract total assets worth $13.17 million. On an average, just 5,236 shares of the ETF exchange hands each day, suggesting wide bid ask spreads.

The index is market capitalization weighted and adjusted for free float. Presently the ETF holds 100 securities from the small cap universe of Australian stocks with allocation of 22.58% in its top 10 holdings.

The ETF is highly exposed to the resource based stocks belonging to sectors such as Materials (27.92%), Industrials (17.88%) and Energy (8.32%) which have slumped badly over the recent past. This coupled with a small cap focus of the ETF has resulted in its dreadful performance in the past one year period, although the fund has come back a little bit in recent months (read China Small Cap ETFs Holding Their Ground).

Nevertheless, the ETF can be an excellent choice for investors to play the recovery in the commodities market. Also, the small cap focus of the fund will cause it to outperform the broader markets once global demand is restored. The ETF pays out a distribution yield of 8.64%. However, it charges a high expense ratio of 69 basis points.

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ISHARS-AUSTRAL (EWA): ETF Research Reports
 
IQ-AUSTRALIA SC (KROO): ETF Research Reports
 
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