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The Globe and Mail

Australia ETFs serve as part-time China plays

I'm a big believer in Australia as an investment theme. The metal-rich nation has been gaining notice from China, which has been buying stakes in Australian companies.

Like the U.S., Australia has wrestled with a faltering housing market and the failure of several prominent companies, including investment bank Babcock & Brown. However, the cycle of Australia's commodity-based economy follows a different track than America's service-oriented economy. Australia just announced the beginning of its first recession since 1991, 17 months after the start of the U.S. recession.

During the last bull market, Australia benefited from sales of natural resources to China, which has been expanding its infrastructure. In the past two years, Chinese stocks have dropped almost 70% on fears that its economy was slowing, causing a 45% decline in Australian stocks.

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China will still move forward with its development plans, though it will be a bumpy ride. The country has been stockpiling copper and trying to invest in or take over companies that operate in Australia such as Oz Minerals, Rio Tinto and Fortescue Metals Group.

The trend will likely continue. China has a large treasury and needs natural resources.

The total market cap of the Australian stock market is approximately $700 billion (U.S.) so a few billion-dollar transactions could have a noticeable effect on the supply of Australian stocks. If demand stays constant, their prices should rise.

U.S.-based investors with exposure to Australia stand to benefit further. Countries looking to make multibillion dollar investments in Australian companies will have to buy Australian dollars.

Two exchange traded funds serve as proxies for Australia. The older of the two, the iShares MSCI Australian Index Fund , invests 25% of its assets in materials stocks. Its largest holding, BHP Billiton , accounts for 16% of the fund.

The WisdomTree Pacific Ex-Japan High-Yielding Equity Fund invests 89% of its assets in Australia and 6% in New Zealand. This dividend-weighted fund has 54% of its assets in financial stocks, and doesn't own BHP Billiton or Rio Tinto.

Choosing between the two funds forces investors to pick the sector they think will rebound first. If materials stocks lead the recovery, the iShares fund will gain. If financial companies come out ahead, the WisdomTree fund will benefit.

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Still, the iShares fund's holdings and its emphasis on natural resources are more true to Australia. It might be the better choice for investors looking for exposure that's more pure.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of "Random Roger's Big Picture Blog."

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