Investing in the Outback: How to Ride the Aussie Bull

Includes: AXJL, CCX, EWA, KROO
by: Brian Foglia

On Tuesday, the Reserve Bank of Australia announced the primary interest rate would be held constant at 4.75%. The RBA raised interest rates seven times between October 2009 and November 2010. It was one of the first central banks to address the financial crisis by doing so. This is in contrast to the Federal Reserve’s fed funds rate of “0-0.25%.” The differences in monetary policy between the two countries highlight the diverging trajectories of their economies. Despite the recent weather problems down under, the Australian economy has been benefiting tremendously from its natural resources and close proximity to Southeast Asia. Below, we’ll discuss some ways to invest in Australia, but first I’ll explain why I believe the bullish case for Australia is so strong.

Unlike most of their regional neighbors, Australians enjoy a highly developed market economy. In fact, the 2011 Index of Economic Freedom ranked Australia the third most free economy in the world, following Hong Kong (undefeated heavy-weight champ) and Singapore. New Zealand ranked fourth, right behind the Aussies. The United States came in ninth, behind Denmark (the horror!).

Australia is a great place to invest if you believe there is currently a secular bull market in commodities. Australians export coal, iron ore, gold, meat and other commodities, primarily to the nearby Asian powerhouses. Because of this, Australia ETFs tend to be more heavily weighted toward the materials sector than other single-country or regional ETFs.

First on our list is the ever-popular iShares MSCI Australia Index Fund (NYSEARCA:EWA). It boasts a low expense ratio of 0.53% and includes 74 Australian stocks, though the top 10 holdings comprise nearly 60% of the entire fund. About 30% of EWA’s holdings are involved in the materials industry. Investors should take note that about 42% of this fund’s holdings are related to the financial sector. Call me paranoid, but considering the swelling uncertainty regarding global financial markets, I would be wary of placing too much trust in banking stocks in the medium to long-term. That said, Australia is one of the least indebted states in the developed world.

Moving on, the IQ Australia Small Cap ETF (NYSEARCA:KROO) is another way to gain exposure. Because this ETF focuses on small cap companies, it is considered to be more of a pure play on the Australian market. These companies are all traded on the Australian Stock Exchange and tend to be more involved in the domestic economy. Keep in mind small cap stocks are generally considered riskier investments than larger, more established firms. What I find most attractive about this ETF is that stocks in the materials sector, such as mining companies, make up the largest component of the fund’s holdings, stacking up to about 35%.

Looking outside the realm of single-country ETFs, the WisdomTree Pacific ex-Japan Total Dividend Fund (DND) allocates the majority of its funds to Australian stocks. It also maintains holdings in Hong Kong, Singapore and New Zealand. For those investors interested in the Australian dollar, WisdomTree also offers a Commodity Currency Fund (NYSEARCA:CCX). The Aussie dollar and New Zealand dollar together comprise a quarter of the fund’s currency holdings. The currencies of Norway, Russia, Brazil, Canada, South Africa and Chile fill out the rest of the ETF’s assets.

I believe the bullish case for the Australian economy stands whether or not one believes the global economy will recover in the short-run. If the global economy recovers, Australians will continue to enrich themselves by trading with their Asian neighbors, who will require Australia’s raw materials, capital goods and technological know-how to continue industrializing. If the global economy “double-dips,” governments around the world will turn to their printing presses to solve their budgetary woes. In this scenario, the countries that produce real assets and commodities will emerge relatively unscathed. In either case, the land down under is the place to be.

Disclosure: I am long KROO.