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Australia ETFs: A Developed Market Play On Asian Growth

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As the global economy continues to slowly improve, many investors are trending back into emerging market equities for exposure. Funds following broad developing market regions are seeing increased inflows while prices of these securities have also risen, helping to erase the memories from the slump of 2011. Yet, unfortunately for many investors, there are still a number of risks in these markets, despite the solid performance to start the period.

High oil prices could crush some of the less commodity dependent nations while a reversal in Europe or North America would definitely hurt the more export-focused emerging markets. Additionally, unrest is beginning to plague some of the more volatile regions, although it still remains muted in many of the larger nations in the world. However, this trend could become a bigger issue as inflation is still a problem that is lurking behind the scenes. This will be especially true if high rates of price increases force more unrest, potentially derailing growth in many markets as the year stretches on.

On the other hand, emerging markets still represent one of the last few high growth regions of the world, suggesting that investors would be remiss to avoid obtaining any exposure to the area. After all, growth in the U.S. is still shaky—especially with current energy prices—and Europe is always teetering on the brink of a recession. Thanks to this potent combination of risks and growth, it may be ideal to play the markets via developed nations in the region, specifically by taking a look at Australia (see Australia Bond ETF Showdown).

Australia remains an intriguing choice for investors looking to gain exposure to a commodity-focused developed market that is increasing its integration with surging emerging Asian markets. Additionally, and probably more importantly given the current investment climate, the country has a robust economy that often puts it head and shoulders above other OECD member states. In fact, Australia has an unemployment rate of about 5.0%, a reasonable budget deficit of just 2.5%, and a low public debt of just 30%.

This suggests a sovereign crisis will not hit Australia’s shores anytime soon and that the economy is already moving along at a decent speed. Furthermore, given the country’s relatively high discount rate, further policy options are at the nation’s disposal, implying that even if there is a slowdown Australia should be better prepared than most.

Yet, looking past the country’s broad strengths, one finds a nation that is increasing tied to the health of emerging markets, especially commodity hungry countries in Asia. These markets are swallowing up Australia’s exports in a variety of industries both in manufactured goods but also in raw materials too. For example, Australia is now the number one coal exporter in the world, while basic metals and coal are also helping to power the country’s robust export economy (See Three Construction ETFs For An Economic Recovery).

Of particular concern to Australia is the health of China and its demand for commodities. Since the nation looks poised to avoid a hard landing, prospects are looking up for Australia in terms of export growth for the foreseeable future. Recent reports by some analysts suggest that increased Chinese demand will help total Aussie exports grow by about 7% for the next five years. This looks to be driven by double digit growth in iron ore and coal exports, both of which are key commodities to China’s growing economy, helping Australia to export close to $28 billion a month.

Beyond China, a number of smaller markets in the Asia-Pacific region are also surging higher, becoming important trading partners with Australia in their own right. Specifically, countries in Southeast Asia, such as Malaysia, Thailand, and Indonesia, are all gaining in importance as their economies continue to industrialize and demand more raw materials. In fact, Thailand looks to become the second fastest-growing export partner, while growth with the quasi emerging market of North Asia’s South Korea looks to rise by about 7% a year for the next five years (see What Bubble? China ETFs Soaring To Start 2012).

For investors intrigued by these trends and Australia’s growing dependence on Asian trade, there are a number of ETFs that offer exposure to the nation. They could make for interesting picks for those who want more emerging market access but would prefer to do it in a way that gives a greater focus on safety. Below, we highlight the four pure play options that investors have when looking at the Australia ETF space. While they all have similarities, investors should note the key differences between these solid options below:

iShares MSCI Australia Index Fund (EWA)

The gold standard in Australia ETFs, this fund has amassed close to $3 billion in AUM, trading close to four million shares a day. The fund focuses in on large cap stocks and has a portfolio of about 70 securities in total, charging investors 52 basis points a year in fees. However, investors should note that EWA does pay out a pretty robust 4.6%, representing a solid yield for a country-specific fund (see Top Three High Yield Real Estate ETFs).

Financials dominate the holdings of EWA making up 37% of the total exposure although basic materials account for another 27% as well. Although the fund only puts 14% of its assets in anything besides large caps (all in mid caps) it does have a nice breakdown between value and growth with both accounting for at least 40% of assets in the product. Current top holdings include BHP Billiton (BHP), Commonwealth Bank of Australia, and Westpac Banking Corp (WBK). EWA has added about 10.6% so far this year, erasing much of last year’s 13.2% slump.

First Trust Australia AlphaDEX Fund (FAUS)

For investors looking for a slightly more ‘active’ approach in Australian investments, FAUS could be worth a closer look. The product utilizes a number of growth and value factors in order to determine the stocks that should be included in the product, eliminating the worst rated and giving higher weights to those that are top rated securities. In total, 40 firms are selected for inclusion, which are then broken into quintiles and are weighted equally among the five groups. Thanks to this, the fund has a large expense ratio, coming in at 80 basis points a year.

Currently, financials and materials both account for 29% and 26%, respectively, occupying the top two spots in the ETF. Beyond these sectors, industrials also make up about 18% while the rest of the sectors do not account for more than 7% of the total. In terms of top holdings, Campbell Brothers, Caltex Australia, Dexus Property, and Tatts Group, are the only four to make up at least 4% of assets. In terms of performance, the fund is too new to compare to the others on the list. It debuted in mid-February of 2012 and thus has no real performance history to speak of.

IQ Australia Small Cap ETF (KROO)

If investors are looking for a small cap tilt in their investment, KROO is the longest running choice. The product targets the IQ Australia Small Cap Index, focusing in on companies that make up the smallest 15% of the market cap in the nation. Currently, the portfolio consists of about 100 securities while charging investors 69 basis points a year in fees. However, the product is still somewhat unpopular with many investors as it has less than $20 million in AUM and sees volume of just over 10,000 shares a day. Despite this, the fund does have an annual yield exceeding 7.5%, suggesting it could be top destination for current income (see For Japan ETFs, Think Small Caps).

In terms of sector exposure, the fund is quite different from its large cap counterpart, EWA. The fund puts its top weightings to basic materials (30%), industrials (26%), and cyclical consumer (17%) stocks. Additionally, it should be noted that the fund puts about 34% of its assets in mid caps and 1% in micro caps, giving the fund a heavy focus on small cap securities. From an individual holding perspective, industrial companies take up many of the top spots, although no one company makes up more than 2.5% of total assets. For performance, KROO has surged in 2012, adding nearly 18.8% in the year so far, helping to, in part, erase last year’s nearly 30.6% collapse.

iShares MSCI Australia Small Cap Index Fund (EWAS)

For investors searching for another small cap play in the Australia space, the recently debuted EWAS could be another option. The fund holds about 206 securities and charges investors 59 basis points a year in fees for its services. Yield information is currently unavailable as the product has yet to pay out a distribution since it just was released on 1/26/12. Thanks to this, the product is still light in volume and assets, having amassed just $2.6 million while trading about 1,250 shares change hands a day in its still short time on the market.

The sector holdings of EWAS are comparable to KROO although there are a few differences. With that being said, the top three sectors are the same in both products although EWAS appears to be slightly less concentrated in these markets. Additionally, EWAS puts close to 45% of its assets in companies that do not fall into the small cap segment, possibly in part thanks to the fund’s inclusion of twice as many companies as its IndexIQ counterpart. However, this also means that the fund is less concentrated as no one firm accounts for more than 2% of the assets in the ETF, a marginal decrease from KROO and its 2.5% top weighting.

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