Aussie ETF, Rio Tinto & Banks

The Australian exchange-traded fund (EWA), a steady performer over the past few years, has been a bit topsy turvey during the last quarter. Normally, one would think that the trouble lies with its top holdings which are oriented to energy and commodities: the titans BHP Billiton and Rio Tinto.

Last year, (BHP) made an all-share bid for Rio which was pushed aside as too low and cash poor. Within the next week, BHP will have to make a decision, sweeten the deal or walk away for six months. It seems doubtful market conditions would improve by then. Given it is an all-share deal, the split of value would not change if share prices fell further and BHP could always alter the exchange ratio.

Despite this, according to the Financial Times, the market still thinks BHP will improve its terms. Rio’s shares are trading 7% cent above the proposed offer and its market capitalisation jumped by $20bn on news of BHP’s approach. Since the offer its shares have outperformed the global sector by 20 per cent.

Rio is off 4% this morning but was up strongly last week. Its share price is up 47% over the last 52 weeks but is trading at a level 28% off its year high. EWA is off 1.9% in early morning trading.

The reality is that for both sides the deal makes even more sense in a bear market than it does in a boom. Pricing power would be improved.

Actually, the problem with the Aussie ETF performance has been the financial sector which represents just under 50% of the ETF holdings, and in particular, its four dominate banks which make up collectively 20% of the exchanges market capitalization. The new government is promoting more competition and has heightened the scrutiny of bank operations. Interloper Bank of the West is also picking up market share using lower pricing as a wedge and the markets fear that overall margins are declining.