Is It Australia's Turn For A Downgrade? ETFs In Focus

Amid concerns over Brexit, sluggishness in emerging markets and global growth fears, Australia, which belongs to an elite group of countries with AAA rating, has come under the scanner. The country’s election held on July 2, 2016, raised the prospect of a hung parliament, fueling uncertainty in the market. As a result, the Australian dollar weakened and the benchmark ASX/S&P 200 also slumped.

Late last month, in the aftermath of the referendum that approved a British exit from the European Union, credit rating agencies – Standard & Poor's and Fitch – downgraded the country's rating. While S&P lowered the nation’s rating from "AAA" to "AA”, Fitch downgraded the country from AA+ to AA. Meanwhile, Moody's has also moved UK's credit rating outlook to negative. A high credit rating helps to keep the cost of public debt low (read: British ETFs in Trouble Post Rating Downgrade, Recession Fears?)

The election results have been indeterminate with neither the ruling party led by Prime Minister Malcolm Turnbull nor the opposition parties able to secure an outright majority. Although analysts are still predicting that Turnbull's coalition is likely to form a government, a hung parliament would also not be surprising.

The political situation in the country is currently fraught with ambiguity, which can continue for some time now. A double dissolution was called by Turnbull several months back after the country's upper house, the Senate, repeatedly rejected labor reform bills aimed at curbing union corruption in the building and construction industry (read: Australia ETFs in Focus on Likely Snap Elections).

Why is Credit Rating at Risk?

A close election will heighten the instability and uncertainty of the government. This will increase the risk of a persistent and deteriorating structural budget deficit and weaken Australia’s AAA stable sovereign rating, as per Su-Lin Ong, head of Australian economic and fixed-income strategy at Royal Bank of Canada and a former Treasury official.

The sustainability of the country's AAA rating was already in doubt after the rating agency Moody's issued warnings earlier this year that the country would be at risk of a downgrade if there are no measures taken to increase revenues considering its mounting debt. Moody's also stated that taxes needed to be raised because of the government’s inability to cut spending enough to keep up with government debt (read: Is Rising Debt Alarming for Australia ETFs?).

Australia’s government debt, which was 11.6% of GDP about 10 years back, has climbed to 35.1% of GDP in fiscal 2015. Moody’s expects debt to increase to 38% of GDP in fiscal 2018.

Moody’s is not alone in considering a rating downgrade for Australia. The other two agencies, Fitch and Standard & Poor’s, had commented on the same lines.

Apart from political turmoil, the country is also fraught with other challenges. It has been under pressure ever since the mining boom ended due to the slowdown in demand from China, one of its largest trading partners. In fact, mining activity was quite modest in the first quarter of 2016.

There are also some warning signs like recession-level wage growth and record-low inflation. The country’s central bank expects moderate jobs growth in the coming months. This is in stark contrast to very strong levels seen in late 2015 (read: Is It Time to Invest in Australian ETFs?).

Due to heightened political uncertainty and other challenges, investors may want to take a closer look at the ETFs targeting this nation.

ETFs in Focus

iShares MSCI Australia ETF EWA

EWA tracks the MSCI Australia Index and holds 73 stocks in its basket. The top two firms have almost one-fifth allocation while other firms hold less than 6.1% share in the basket. From a sector look, financials dominates the fund’s return at 50.9% followed by materials (13.3%). This fund has an AUM of $1.6 billion and average daily volume of more than 3.5 million shares. It charges 48 bps in annual fees and has gained 4.5% so far in the year (as of July 1, 2016). It has a Zacks ETF Rank of 3 or ‘Hold’ rating with a Medium risk outlook (read: Most Vulnerable Asia-Pacific ETFs on China Issues).

WisdomTree Australia Dividend Fund AUSE

This fund follows the WisdomTree Australia Dividend Index. It has an AUM of $33.5 million and trades in paltry volume of 2,800 shares a day on average. Expense ratio comes in at 0.58%. Holding 66 stocks in its basket, the product is widely diversified as none of the components holds more than 3.2% of assets. Sector-wise, it has a definite tilt toward financials at 22.9%, followed by materials (17.8%), consumer discretionary (14.6%) and industrials (11.3%). The fund has gained 10.6% so far this year and has a Zacks ETF Rank of 3 with a Medium risk outlook.

iShares Currency Hedged MSCI Australia ETF HAUD

This ETF tracks the MSCI Australia 100% Hedged to USD Index and invests primarily in EWA with currency hedge tacked on to it. The fund has accumulated $7.6 million in its asset base since its inception and charges 51 bps in annual fees. Volume is paltry as it exchanges 6,000 shares on average on a daily basis. It has gain almost 1.0% so far this year. The fund has a Zacks ETF Rank of 3 (see all Asia-Pacific Developed ETFs here).

SPDR MSCI Australia Quality Mix ETF QAUS

This fund tracks the MSCI Australia Quality Mix A-Series Index. It has a basket of 75 stocks with the top firm having an exposure of almost 7%, while the rest of the firms have less than 5.4% weight. Here again, financials takes the top spot at 43.9% while consumer staples and materials round off the next two positions with double-digit exposure each. QAUS has AUM of only $9.3 million and average daily volume of around 1,400 shares. Expense ratio comes in at 0.30%. The fund has gained 5.8% in the year-to-date timeframe and has a Zacks ETF Rank of 4 or ‘Sell’ rating with a Medium risk outlook.

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ISHARS-AUSTRAL (EWA): ETF Research Reports

SPDR-MSCI AQM (QAUS): ETF Research Reports

ISHARS-CHM AUST (HAUD): ETF Research Reports

WISDMTR-AUS DVD (AUSE): ETF Research Reports

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