Recent statements from Reserve Bank of Australia (RBA) Governor Glenn Stevens have changed the country’s interest rate outlook for the remainder of this year. Citing relatively stable consumer inflation levels (that are still well below the RBA’s target of 3%), Stevens’ has essentially prepared markets for a more supportive policy environment that will generate downside pressure on the Australian dollar and put a floor under the benchmark S&P/ASX 200 stock index in coming months. When we look at Australian stocks on a comparative basis, this creates some attractive scenarios for investors looking for long-term exposure to markets outside the U.S.
The declines in the S&P/ASX 200 that were seen in May and June sent market valuations to new yearly lows at a time when the benchmark’s U.S. counterpart was pushing forward to new all-time highs. But when we look at the relative central bank stances in both countries, trends like these start to look misplaced. Specifically, quantitative easing programs in the U.S. are likely to see reductions in monthly asset purchase amount as early as September. Several voting members at the U.S. Federal Reserve have already been vocal about the disruptive effects of these seemingly endless stimulus programs and have called not only for their elimination but for a return to normalized interest rate policies as well. In short, stock markets in the U.S. continue to trade near record highs as stimulus programs will soon be discontinued. This marks a strong contrast to the environment that is beginning to unfold in Australia.
Banking on the RBA
The measures that have been most recently proposed by the RBA will make investments in the country’s currency less attractive, given the reduced yield incentive that will be present for those holding the currency long term. This is a negative for those with holdings in the CurrencyShares Australian Dollar Trust (NYSEARCA:FXA), which tracks the value of the Australian currency. But the exact opposite is true for investors with exposure to Australian stocks – especially for companies with a strong export base. Supportive monetary policy on the domestic front is now coupled with a declining exchange rate (making Australia’s export products less expensive for foreign customers), and a broader stock market that is priced cheap relative to its global counterparts. All of this points to long-term upside in Australian stocks.
So, how can we play these themes in the active market? One of the easiest options is to use closed-end funds that offer exposure to companies in the region. Closed-end funds offer a fixed number of shares, tying valuations more closely to supply and demand (as opposed to net asset value, or NAV).
One strong choice in this space is the Australia Fund, which has a market cap of $229 million and positions itself for long-term capital appreciation using equities listed on the Australian Stock Exchange (ASX).
Closed-end funds still well priced
From a valuation perspective, IAF is characterized by strong upside momentum and is currently trading at a premium of 13.5%, relative to NAV. Valuations like this in closed-end funds suggest that strongly bullish sentiment is present in the market, and when this is coupled with its incredible dividend yield of more than 10%, IAF starts to look very attractive for investors with long-term time horizons. The Fund’s well-diversified portfolio is positioned to capitalize on the RBA’s supportive stance for exporters, and its elevated dividend payouts will help investors ride out any of the potential volatility that is generated once policy changes at the central bank start to take effect.
Alternatively, investors can look at the Aberdeen Australia Equity Fund Inc (NYSEMKT:IAF) Aberdeen Asia-Pacific Income Fund, Inc. (NYSEMKT:FAX), which offers a better contrarian play with a discount along with its already attractive 5.5% dividend yield. Aberdeen Asia-Pacific Income Fund, Inc. (NYSEMKT:FAX) is much better diversified from a regional perspective as well. Exposure in Australian assets makes up 38% of the fund, with the remainder devoted to developing markets. Assets tied to South Korea make up 9% of the fund, and positions in Malaysia and the Philippines come in next at 7% each.
Finding discounts
The fund has seen some selling in the early parts of the year, and now trades at a 7.5% discount to NAV which gives investors the opportunity to buy into these assets at a cheaper level than would be available individually on the open market. Recent credit upgrades for assets held by the fund create a strong outlook into the later parts of the year, and positions here allow investors to capitalize on the policy changes at the RBA while still taking advantage of the cheaper valuations and growth prospects present in emerging markets.
In all, Aberdeen Australia Equity Fund Inc (NYSEMKT:IAF) and Aberdeen Asia-Pacific Income Fund, Inc. (NYSEMKT:FAX) offer the potential for stability and growth, along with excellent dividend yields at a time when the macro environment is starting to favor Australian markets. This marks a large contrast when we compare these stocks to U.S. benchmarks. So, for investors looking to gain new regional exposure, Aberdeen Australia Equity Fund Inc (NYSEMKT:IAF) and Aberdeen Asia-Pacific Income Fund, Inc. (NYSEMKT:FAX) look very attractive.
Rick Bartlett has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Rick is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Supportive Rate Outlook to Benefit Australia Funds originally appeared on Fool.com is written by Rick Bartlett.
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