How to benefit from the falling Australian dollar
As the Australian dollar hits 20-month lows, it may be wise to consider unhedging some international investments, according to several experts.
As the Australian dollar hits 20-month lows, it may be wise to consider unhedging some international investments, according to several experts.
Falling to just over 70 US cents over the weekend, the declining Aussie dollar boosts returns from unhedged international investments. So, if the Australian dollar falls by 5 per cent against the US dollar, the value of US equity investments would rise by 5 per cent when converted back into local currency.
"As the Australian dollar falls the value of unhedged offshore assets effectively increases, all other things being equal," says Rob Holder’s, asset allocation specialist with Crestone Wealth Management
He says investors holding unhedged positions will benefit via greater returns, but the opposite also holds true. If the local dollar rises, then offshore investments lose their value in local currency terms.
Some analysts expect the Australian dollar to move still lower. Bill Evans, chief economist at Westpac, recently predicted the Australian dollar would fall to 70 US cents in 2019. He expects the Australian dollar to recover slowly to around 75 US cents through 2020.
The Australian dollar was trading at just below 72 US cents at the market open on Monday 3 September, having been stuck between 72 and 75 US cents since July – from a high of 81 US cents in January.
In contrast to Westpac, Commonwealth Bank currency strategists predict the Australian dollar will rise to 75 US cents by December 2018, and 77 US cents a year later.
A volatility cushion
Typically, the Australian dollar moves with offshore stock markets. So, if stock markets correct, unhedged international investments can provide a valuable portfolio cushion against losses.
"In the past we have seen the Australian dollar act as an insulator in times of market stress. This is because the Australian dollar has tended to decline in risk-off environments, so as the value of the underlying assets falls, so does the Australian dollar,” says Crestone's Holder.
But over time, currency risks balance out, and hedging may not be necessary, according to Robin Bowerman, principal and head of corporate affairs, Vanguard Investments Australia.
Referring to research it has conducted into the 30 years between 1986 and 2016, he says: "The Australian equity/currency correlation was mostly positive, suggesting little to no benefit to equity hedging".
"However, given there were periods of greater and lesser volatility, the research also concluded that some level of partial hedging was shown not to be detrimental to the portfolio," Bowerman says.
He emphasises that hedging strategies do have an associated cost, "so a reduction in short-term volatility should be weighed up against this," Bowerman says.
He notes that Australian ETF investors can typically access both hedged and unhedged international equity ETFs. "In Vanguard’s case there is a small additional [0.03 per cent] management fee between our hedged and unhedged international share ETF portfolios, to account for the additional portfolio management required."
The asset class is also important. Crestone’s Holder says if you are investing in a defensive asset class like fixed income, where capital stability and income are key aims, then removing the volatility associated with currency movement is very important.
He suggests investors who are more sensitive to shorter-term volatility "may prefer to carry less currency exposure and to hedge it, perhaps partially".
“However, if you are investing in equities for growth over the long term, then potential currency fluctuations are less of an issue.
"In general, currency markets have proven notoriously difficult to predict and making dramatic shifts in hedging policy could be likened to market timing, which is not a strategy that we advocate," Holder says.
Global hiccups would hammer AUD
Yet some wealth experts are recommending investors retain unhedged international investments.
Andrew Lord, a director at wealth management firm Sherbrook Private, expects the currency to weaken further. In response, it remains fully unhedged, with provision to partially hedge dollars "if we feel it is appropriate".
"Any hiccup to global growth is going to hammer the Australian dollar. The last time we saw US Treasury 10-year bond yields lower than Australian yields, the dollar was in the 50 US cents range.
"Not to say this will happen while exports are strong, but if things slow – and it definitely could, because the US Fed will be hiking rates quicker than the Reserve Bank," says Lord.
However, he adds that US markets aren’t cheap “so it is conceivable that you make money on a declining currency, but give it up on the underlying investment – plus some.”
Comparative performance for Australia, US and All-World share market indices
February 2008 - February 2018
Source: Bloomberg
Portfolio diversification benefits
There is good reason to invest offshore, with Australia’s share market small in comparison to other key exchanges. It also lacks the diversity of some major off-shore securities markets, being dominated by banks and miners.
In addition, returns on offshore shares have outstripped those on local shares in recent years – bearing in mind that past performance is no guarantee of future returns.
Comparing the 10-year performance of the Australian, US and global indices between 2008 and 2010, the S&P 500 returned 103 per cent; the MSCI World index grew by 45 per cent, and Australia's S&P/ASX200 grow just 6 per cent, as the above chart shows.
More from Morningstar
• Make better investment decisions with Morningstar Premium | Free 4-week trial
Nicki Bourlioufas is a contributor for Morningstar Australia.
© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.
