Australia ETF Could Face A Surprising Headwind

The iShares MSCI Australia ETF (NYSE: EWA), the largest Australia exchange traded fund listed in the United States, could contend with an issue often reserved for single-country ETFs devoted developing economies: credit risk.

The $1.72 billion EWA is up 19% year to date, good for one of the best showings among single-country ex-U.S. developed markets ETFs. Strength in Australian stocks has been facilitated by accomodative monetary policy by the Reserve Bank of Australia.

Although the RBA has taken borrowing costs down under to historical lows, EWA remains an alluring high dividend play with a trailing 12-month yield of 5.26%.

Why It's Important

While the Australian economy has dodged a recession for more than three decades, at least one major ratings agency believes the country's AAA credit rating could be imperiled if the economy there weakens.

“As the official cash rate in Australia moves toward zero there have been growing calls for the government to increase fiscal stimulus,” Standard & Poor's said in a new note. “If this fiscal stimulus involves substantial spending initiatives and changes the trajectory of the budget, then doing so could increase downward pressure on our rating and outlook for Australia.”

Australia is one of just 11 countries in the world with the prestigious AAA rating and one of just two in the Asia-Pacific region. Singapore is the other. Eight of the other nine are European nations.

What's Next

The good news is that S&P has long since had a “stable” rating on Australia's AAA rating and that hasn't adversely affected assets there. Additionally, history shows a country's economy and markets can perform well after losing the AAA rating with the U.S. standing as the most prominent example.

“The economic significance of the AAA rating is limited, with S&P’s announcement in 2016 that it was cutting Australia’s outlook to negative from stable eliciting a yawn from currency, bond and equity markets,” according to Bloomberg.

EWA holds nearly 70 stocks and its standard deviation is just 11%, indicating it's a relatively low volatility play as far as ex-U.S. single-country funds are concerned.

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