A few days ago I was here talking up owning high-yielding global ETFs as an income-generating tactic for diversifying a dividend-income portfolio. I'm not going to rehash the arguments in favor of global diversification or the use of income-generating ETFs to achieve it in a dividend-income portfolio. If you missed it, please take a look at the article here. There's some excellent input from some very knowledgeable commenters - not all of whom agree with my premise, I'll add - that you may want to review as well.
Part of that focus on that article was on funds that look toward the MSCI EAFE index as a benchmark. Now, I'm sure everyone here is well aware of the MSCI EAFE index's place as the benchmark standard for developed market performance, right mates? So, here's a quick quiz: What does that "A" stand for? Hint: The "E" stands for Europe. Ok, show of hands here.
Oh, lots of hands up. Ok, you in the back. What's that you say? "Asia?" Nooo. Anyone else?
Hey, where'd all those hands go? Oh, there's one. Ah, well done. It is Australia.
Ok, I'm sure most of our Seeking Alpha readers knew full well what that "A" stood for. But I'm just as sure many investors overlook the Australian economy as an investment opportunity. Perhaps one reason that Australia tends not to get the respect it deserves follows from its lowly position on the world map as most of us visualize it. There's poor Australia, always tucked away down in a lower corner of a map projection that makes this continent look like a large island. Indeed, most common maps use a variation on the Mercator projection which shows Greenland, an island, as being much larger than the Australian continent. So let's start by letting Oz out of its corner.
There we go; that's better. But that island in the lower corners is still huge compared to the continent. Can it really be that small?
Notice that all of Europe would fit handily within Australia's area with nearly half the land mass uncovered. Of course, there's a lot of vast nothingness in the outback. But, a lot of that vast nothingness is exceptionally resource rich. That richness drives the Australian economy's materials sector and provides a lot of Australia's appeal to an investor seeking sector as well as global diversification.
Australia came to my attention in a big way from that earlier exercise on international dividend-paying funds. There were 4 developed-world equity ETFs paying distributions in excess of 4.8%. Three of them were global funds that included the U.S. equity market, and for those the U.S. is also their top country holding. The other was ex-U.S and the top country position in its portfolio is Australia. More interesting is that for each of the 3 ex-U.S. funds, Australia was number 2. Clearly, managers seeking international income opportunities in developed countries are looking hard at Oz.
With that in mind, here's the low-down on down-under.
I've come up with 3 ETFs that cover the continent and pay at least 4% distributions. Two are well established: iShares MSCI Australia Index Fund (EWA), WisdomTree Australia Dividend Fund (AUSE). The other is the new kid: Australia AlphaDEX Fund (FAUS).
Avg. Daily Volume
Annual Dividend Yield %
Each of these three provides attractive distribution income, but price performance has been lackslustre for the past three years through the beginning of last quarter. All three have move up reasonably sharply since the end of summer, but that followed a serious slide earlier in the year. Here's a look at comparative performance data on the three funds:
A look at what has happened in this time period is instructive. A large part of the return from Australia's investments reflects its close economic ties with China. In 2009, mining activities comprised 10% of Australia's economy with much of that driven by China's seemingly insatiable appetite for mineral resources. The slowdown in China had a severe negative impact on Australia. As China picks up again, it's not unreasonable to anticipate a correlated uptick in Oz as well.
The other factor is currency risk. The Australian dollar is a volatile currency. Some will argue that this high currency risk and the disproportionate reliance on commodities associated with Australian investments puts the country more in line with emerging markets than developed-world markets. Considering the chart above together with the recent history of emerging market investments would tend to support that view.
The recent upturn is largely attributable to a strong performance of the Australia's financial sector and its high-yielding defensive sectors. Each of these funds is heavy in those sectors. Here are the top 3 sectors for each:
Although returns have been sluggish for several years, several analysts are seeing indications of a turnaround in Australia as the global economy improves. There has been a recent upsurge (see the last quarter results above) that correlates with similar movements in the other EAFE economies. Later in this article, I show a comparison with the U.S. dividend fund, SDY, that is worth pondering for some back history on how these funds compare with the U.S. market.
Distributions and Income
Dividend-income investors will want to know about distributions. Two of the funds have sufficient distribution history to provide a picture of how they have delivered over time. Here then is that history:
An investor used to U.S. dividend stalwarts will notice right away that there is year-to-year volatility in these results. For the rest of the world, this is an accepted (although perhaps not quite acceptable) market response. Anyone invested in global equities will have to accept it as the reality. Another difference is that U.S. companies pay dividends quarterly. U.S. ETFs also typically pay their distributions quarterly as well (some funds that focus on income even pay monthly). EWA pays semi-annually. AUSE went to quarterly payments in 2009, and FAUS pays quarterly.
How do these funds compare to an income portfolio based on U.S. dividend equity holdings? Here's a performance chart for EWA and AUSE compared to SDY, a surrogate for that U.S. dividend portfolio:
Correlation and Potential Diversification
If one's objective here is to provide global diversification, the obvious question one must ask is: "How much diversification do these funds provide?" Again, I will only look at the funds with a reasonable back history: EWA and AUSE. The correlation values are shown here.
Nothing unexpected: The 2 Australian funds are highly correlated with each other and meaningfully less correlated with the U.S. portfolio. The dividend-weighted fund, AUSE, has a somewhat lower correlation coefficient with SDY possibly as a consequence of its dividend-weighting tactic as well as its lesser commitment to the Australian financial sector. In addition, AUSE holds no positions in real estate which is the fourth largest sector in EWA's portfolio at 7.5%. EWA has a combined 50% of its holdings in Financials and Real Estate.
It is worth noting that the correlations here are somewhat lower than the range for the broad market EAFE funds discussed earlier (here). Once again, they more closely resemble emerging market ETFs than their EAFE peers.
Closed End Fund
There is one closed end fund that covers the Australian equity market: Aberdeen Australia Equity (IAF). The CEF pays an appealing 9.30% yield on its current market price. But the fund may not be as attractive as the yield might imply. It is currently priced at a 13.52% premium to its NAV, nearly 75% above its 52 week average premium of 7.8%. On that basis alone, I would pass on this one.
The funds ability to sustain either its premium valuation or its high distribution yield is also questionable. It is distributing 10.48% on a NAV basis, but its total return on NAV for the year is only 3.95%. That's a big gap to make up. Undistributed net investment income is a negative $0.41/share.
IAF certainly does not appear to me as a wise investor's choice for exposure down under.
Oz Funds in Perspective
One thing that should be clear from the above: EWA is the heavy hitter in the Australian ETF lineup. AUSE is one of Wisdom Tree's dividend-weighted funds. It carries the dividend focus in its name. Yet, it trails both EWA and FAUS in delivering income-return to its shareholders. Combine that with its lack of liquidity relative to EWA and it tends to fall by the wayside.
FAUS is really too new to allow an analysis one can feel strongly about. Its mangers employ a fundamental-weighting with a secondary focus on income returns. But, the fund's brief history provides no real evidence that its strategy is productive here. I've looked at fundamental-weighted funds in several contexts recently (take a look at this article for an example) and did not find a consistent benefit to the approach. FAUS also shares a problematic liquidity issue with EWA.
Summarizing here, there seems to only one good reason to venture from the big dog for an investor interested in Australian exposure. Its returns are essentially equivalent to the other two funds (which is interesting when one considers the difference among them in sector allocations). It has the highest distribution yield. And it has, by far, the least concern regarding liquidity, trading 1.5M shares a day compared to less than 10,000 for the other two funds. Unless one's overriding priority in seeking out this category is that it provides enhanced diversification and lower correlation with U.S. equities, EWA looks like the vehicle of choice for investing in Oz. If, on the other hand, one is primarily interested in decreasing overall portfolio correlations, AUSE deserves greater consideration.
As always, I remind readers that I am an individual investor. I have no claims to professional expertise of any sort in stock evaluation. I am simply sharing my own research in the hope that it may be useful to others. Any actions a reader may want to take based on this research must necessarily include his or her own careful due diligence and full consideration of his or her individual goals and need.