Australia: The Undiscovered Country

Author: Eric Uhlfelder

23 November 2009, Private Wealth

Few advisors know that Australian stocks have delivered the most consistent returns of any developed market over both the short and long term due to the strength of the country’s markets and economy, which has seen 17 consecutive years of uninterrupted growth.

Vacationers know her beaches and coral reefs. Wine connoisseurs know her vintages. But few investors know the advantages offered by this remarkable country.

Dollar-based total returns of Australian shares have been stunning. They have consistently outperformed developed equity markets across the globe. Over the past year through 13 November 2009, MSCI reports the Australian market has soared 95 percent. No other market did better. The same holds for the trailing three years with Australian stocks averaging annualized returns of 7.49 percent. Five-year annualized returns of 14.04 percent were bested fractionally only by Spain. And over the last decade, Australian stocks again led the way, averaging total returns of 13.99 percent.

Despite the current strong rally, both the MSCI US and EAFE [the benchmark international equity index] pale miserably. Domestic 1-, 3-, 5-, and 10-year annualized returns were 23.93 percent, -5.27 percent, 0.74 percent, and -0.64 percent, respectively. Foreign market returns weren’t much better: 43.57 percent, -3.79 percent, 5.38 percent, and 2.84 percent.

As a source of secure income, Australian commonwealth sovereigns, AAA-rated government bonds, have traditionally yielded several percentage points more than US Treasuries across the yield curve. As of mid-November, Australian yields were collectively averaging 5.43 percent versus US yields of just 3.02 percent , according to the J.P. Morgan Overseas Government Bond Index. And there is a huge spread in short-term yields. One-year Treasury notes were yielding a mere 36 basis points; Aussie Sovereigns due in eight months were yielding 4.25 percent. Venturing into AAA-rated State bonds gets you an additional 50 basis points, and AA-rate corporate bonds up to another 150 basis points.

Further supporting these opportunities is a currency that’s been steadily appreciating against the dollar for a number of years. Since getting knocked back by the unexpected dollar rally at the end of last year, the Aussie dollar has rallied 50 percent against the greenback over the past twelve months through November 13. For unhedged investments in Australian securities, that appreciation went straight to the bottom line.

“Australia’s economy has been broadly protected from the economic storm raging in the rest of the world,” reports the Economist Intelligence Unit. While jobs have been disappearing at an alarming rate across many developed markets, Australia’s unemployment rate of 5.7 percent has increased by only 1.5 percentage points over the past year. And has remained flat since June.

EIU reports that house prices have barely budged from historic peaks in 2007. With virtually no subprime exposure and loan arrears remaining small, the country’s banking system has held up well, having remained profitable throughout the financial crisis, enabling lenders to stimulate growth.

“Most important,” notes the EIU, “the country’s trading position with Asia, and especially China, is flourishing. China, where growth is booming again, is now Australia’s largest trading partner. Exports of raw materials have grown from 20 percent of Australia’s exports to more than 40 percent in the past decade.”

All of these factors have helped the economy avoid recession. It expanded 2.4 percent in 2008 and is projected to end 2009 having grown by 1.0 percent. That will mark the 17th consecutive year of GDP growth that’s been averaging well north of three percent annually. “That defies statistical logic,” observes Derek Izuel, manager of Highmark Capital’s Core Equity fund, with more than a decade of experience managing global portfolios. He believes there hasn’t been a reversion to more earth-bound averages because Australia is an atypical market.

“The country is unique–a huge mineral rich, economically-diverse land mass hosting a small population of just 22 million people,” explains Izuel, “that’s complemented by well-capitalized banks.” Four of the world’s large AA-rated banks are Australian. And Izuel reports that the country “enjoys strong corporate governance and regulatory environment that support an efficient, established market place.”

Another compelling aspect of the country is its competitive standing globally. In its latest review of quality of business environment, the EIU ranked Australia seventh, six notches ahead of the US.

Reflective of the government’s growing confidence that the economy has weathered the storm, the country’s central bank, the Reserve Bank of Australia, has been raising interest rates. After having eased monetary policy from 7.25% in March 2008 to 3% in March 2008, the RBA was the first developed market central bank to start pushing rates up: 25 basis points in October and again in November.

Despite all of the country’s positives, most globally diversified investors have only limited exposure to this powerhouse. Advisors who have purchased the international index, EAFE, have provided clients with only 8.23 percent exposure to Australia. When relying on the MSCI All World Country Index, exposure falls to 3.31 percent.


The Australian stock exchange is dominated by three sectors: finance represents 27.5%, materials 22.9 percent, and consumer staples 14.2 percent. Within these groups, Australia has a number of industry leaders, many of which trade in the US.

BHP Billiton is the world’s largest and most diversified resource company, which produces petroleum, aluminum, copper, gold, iron ore, coal, nickel, and diamonds. Its earnings and stock price have been growing at nearly 30 percent and 26 percent annual clip, respectively, over the past five years. The current PE is 18. According to Morningstar analyst Mark Taylor, keys to BHP’s success are its low-cost operations, a strong balance sheet, and operations that are based in the relatively safe havens of Australia, New Zealand, North America, and Europe. He believes the company is an ideal way to play economic recovery and the accompanying rise in commodity prices.

Macquarie Group is one of the world’s most innovative investment banks. With a focus on infrastructure, the bank specializes in buying assets around the world and profits from setting up specialized funds that eventually hold them. While shares got slammed by the banking crisis, they’ve rebounded close to their 52-week high. The reason, explains Morningstar analyst, Peter Warnes, is that the bank has been free of unusual provisions or write-downs. It hasn’t been exposed to problem trading or poor credits. He observes that Macquarie’s “risk policies are closely aligned with those of Goldman Sachs, which has provided added confidence in its management and risk policies.”

Macquarie’s average earnings growth rate over the past five years has been running north of 22 percent, with annualized price returns of more than 10 percent, and a current PE of 16.5. Investors enjoy a 4.7 percent dividend.

Australia also has strong commercial banks: Australia & New Zealand, Commonwealth Bank of Australia, and Westpac. They have generated annualized net income growth near or into the double digits over the past five years and pay dividends exceeding 4 percent. Their stock prices have all appreciated from 8 to more than 11 percent annually over the last five years. Rich dividends have pushed these returns even higher. And after investors dumped shares indiscriminately during the eye of the banking crisis, these shares have all rebounded near their 52-week highs.

Woolworths Limited is known as the WalMart down under, and it might be even better. Its shares barely budged during the crisis. Annual earnings, dividend, and stock price growth has averaged more than 16 percent over the past five years as the company continues to thrive. Morningstar’s analyst Warnes describes “Woolworths as a growth stock with significant defensive qualities, possessing a strong balance sheet, and a wide competitive moat characterized by extensive supply chain operations and intimidating buying power.” And it offers a 3.8 percent dividend to boot.

Healthy dividends are a trait of Australian stocks, which is why they are the second largest holding in the ING International High Dividend Equity Income Fund. The country represents 12.5 percent of manager Martin Jansen’s portfolio. But he is keen on Aussie shares not just because of high, sustainable payout ratios, which are around 15 percentage points above US standards. “Substantial distribution of profits to investors demands a greater discipline in the use of remaining capital and certainty about rates of returns on new investments,” says Jansen, “which has been confirmed by academic research that reveals that these stocks tend to have lower betas and volatility over the long run.”

Leading Australian Equities


While carry-traders venture into emerging markets like Brazil to capture higher interest rates, Australia is likely a safer way to increase income by hundreds of basis points over US Treasuries. As of November 20, according to a Sydney-based Citigroup senior economist Josh Williamson, Australian Commonwealth Government Bonds due in August 2010 were offering yields to maturity of 4.12 percent. April 2012 sovereigns’ annualized returns are 4.74 percent. State bonds, like those issued by New South Wales were paying even more, 5.07 percent for May 2012 issues. “Investors can be rewarded even more by going out longer,” remarks Williamson, “but with interest rates likely to be trending higher over the next year, investors may be better served staying short-term and rolling over proceeds into perhaps subsequently higher yielding bonds.”

“AA” rated corporates can deliver even greater yields with only marginally greater risk. Citigroup’s Australian Credit Strategist Mark Reade points to ANZ’s September 2010 bonds that have a YTM of 5.1 percent, its March 2011 offering that delivers nearly 5.5 percent, and Westpac’s June 2011 issue that’s returning 5.9 percent.
A weakening Australian dollar versus the greenback is the significant risk in these plays. But with Australia’s solid macroeconomics and the Reserve Bank of Australia already in a rate-tightening mode, most currency analysts see a greater likelihood of the Aussie dollar strengthening, which would add to US investor returns.


Investing in a market-cap weighted index of the Australian market has been a simple, liquid and inexpensive way of capturing the country’s equity performance and alpha above traditional international equity exposure through EAFE. An investor can purchase these New York Stock Exchanged-listed iShares MSCI Australia [EWA] at the same cost as ordinary stock. They trade throughout the day with average daily volume exceeding six million shares. The ETF passes on a tax-qualified dividend that’s currently above 4 percent, and its annual expense ratio is 52 basis points.

Not surprising, three-quarters of the performance of this $2.4 billion fund is driven by materials and resources [41 percent] and financial services [34 percent]. It’s top five holdings are BHP Billiton [14 percent], followed by the country’s big four banks. Commonwealth Bank of Australia, Westpac, National Australian Bank, and Australian and New Zealand Bank, which comprise nearly 30 percent of the fund.

Through November 20, EWA has soared more than 127 percent over the past 12 months, outperforming EAFE by 74.47 percent. Three-year annualized returns were up 6.24 percent, outpacing the benchmark by nearly 11 percent. Five- and ten-year annualized returns each gained a fraction over 12 percent annually, outperforming EAFE by 7.77 and 10.19 percent, respectively.

Philadelphia-based Aberdeen Asset Management offers the only actively managed portfolio, marketed here in the states, that provides pure exposure to Australian stocks. Aberdeen Australia Equity [IAF] trades on the American Stock Exchange and has been outperforming the Australian MSCI benchmark.

While adequate for most retail investors, the fund’s liquidity differs from the iShares ETF. It has smaller daily trading volume that averages about 61,000 shares. As a closed-end fund, investors are not buying shares of the underlying stocks at their net asset value but at what the market values the fund. This produces a variable when purchasing and selling fund shares, as well as in measuring performance.

According to Morningstar, the fund’s market price has generally deviated from its NAV by as much as 10 percent since 2005. In November of last year, when investors were fleeing stocks, one could have purchased IAF at a 9.56 percent discount to the worth of its shares. A year later, the fund’s market value was actually 10.29 percent above the value of its portfolio, having temporarily spiked to nearly 20 percent.

The fund’s composition is a bit more diversified than the MSCI Index, with industrial materials making up 32.5 percent and financials 26.1 percent. Its top five holdings, also representing more than 40 percent of the fund, is also different. While it’s topped by BHP Billiton [14.65 percent], manager Mark Daniels also has an 8.19 percent position in Rio Tinto, Australia’s other major resource giant. QBE Insurance represents 6.48 percent, followed by Westpac [6.31 percent] and Woolworths [5.30 percent].
The higher cost of active management [1.47 percent annual expense ratio] has paid off.

One-year total returns through November 20 were a whopping 168.29 percent, flying past MSCI Australia by more than 40 percent. Three-year annualized returns were 6.94 percent, topping the local benchmark by around 70 basis points. Five-year and ten-year annualized returns of 14.11 and 14.57 percent, respectively, each topping the domestic index by more than 2 full percentage points. Inclusive has been a hefty dividend that’s currently near 4 percent.

There are a number of local investment trusts, equivalent to our mutual funds, trading only in Australia. But several can be purchased directly by US investors. One is run by Wilson HTM Asset Manager, who runs more than A$8 billion. It started its small-cap focused Priority Growth Fund in 2005, and has seen its assets grow to A$100 million on the back of 3-year annualized returns [in local currency terms] of 23.3 percent through October. Minimum investment is A$40,000, its management fee is 1.25 percent, and it levies a performance fee of 20 percent annually on profits above the S&P/ASX Small Ordinaries Accumulation Index.

Tim Murphy, cohead of funds research at Morningstar Australia, found two large-cap funds with solid long-term track records also open to foreign investors. The A$3 billion Ausbil Australian Active Equity Fund has generated 10-year annualized returns of 12.38% through October. Minimum investment of is A$50,000 with a management fee of 90 basis points. Ten-year annualized returns of the A$1.2 billion Schroder Australian Equity Fund are 11.24%. Minimum investment is A$500,000 with management fee of 57 basis. These two funds don’t collect performance fees.

Another way in which investors have been able to access the strength down under has been through its currency. Rather than seeing currency exposure as an outright risk, retail investors are realizing what sophisticated investors have known for some time, that currency is an asset class, reflective of the overall economic and political strength of an economy. As such, it can be a source of alpha. And no where has this been more true than with the Australian dollar, which has rallied 50 percent versus the greenback over the past year.

One of the easiest ways to gain short- or long-term currency exposure, avoiding rolling over derivative contracts, is with Rydex SGI, which has set up funds that track the performance of each of nine different currencies, including the Australian Dollar. The CurrencyShares Australian Dollar Trust [FXA] was started in June 2006 with $11 million. Each share is worth A$100, making it is easy to contrast the currency’s exchange rate versus the US dollar with the share price. For instance, on November 17, the fund’s NAV was $93.81, just 32 basis points higher than the Interbank rate. Shares trade continuously on the NYSE, with daily volume that averages more than 272,000.

Despite a significant swoon in the Aussie dollar late last year as investors flocked to safe-haven currencies, performance of FXA has been impressive over its brief trading history. Over the past year, the fund was up 47.20 percent. That was nearly triple of what Deutsche Bank US Dollar Bear Index, a basket of six of the world’s most widely traded foreign currencies, delivered over the same period, which was up 17.52 percent. And over the past three years, the Aussie Dollar fund averaged annualized returns of 11.96 percent, besting the foreign currency basket by over eight percent.

Investors also benefit from the structure of the Trust, which keeps assets in demand deposit accounts. It pays Aussie Dollar overnight LIBOR. This interest is channeled monthly to investors. In the middle of November, the yield, net of depositary fees and fund expenses [40 basis points annually] was 2.27 percent.

Everbank World Markets also provide another efficient way to gain exposure to the Aussie Dollar. It offers investors 3-, 6-, and 12-month CDs that are currently paying an annualized yield of 2.02%, 2.26%, and 3.50%, respectively.

Australia is not a panacea for market risk. As seen last year, the country is vulnerable to global shocks. While the current rally is a symmetrical response to the preceding severe sell-off, profit-taking and a correction is likely over the near term. The same holds true about the rapid rise of the Australian dollar. Currencies don’t move in only one direction. And when US interest rates start to rise, traders may respond by supporting the greenback. Until then, prolonged appreciation of the Australian dollar could erode the country’s export strength and foreign direct investment into Australia.

But extraordinarily rapid recovery of its equities and currency speak of Australia’s underlying strength. And with most market observers believing that emerging markets are going to the strongest sources of growth going forward, achieving this exposure through the security of a strong developed market may be the safest way ahead.



  • Online access to extensive equity, fund, market reports, and real-time quotes.
  • Economist Intelligence Unit: Online qualitative and quantitative country, markets, and risk reports, via
  • International Monetary Fund Article IV Country Consultations: Annual reviews of a country’s macroeconomics strengths and weaknesses via
  • Organization for Economic Cooperation and Development Country Surveys: Analysis of various macroeconomic, industry, and government policy trends, via



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