If you’re planning to invest in offshore assets, then the decision whether to hedge your currency exposure is an important one as movements in the Australian dollar can either erode or add value to your investment. 

Any rise in the Australian dollar diminishes returns when assets are converted into the local currency.

Any fall helps investors as it magnifies gains when assets are converted into local dollars.

So if, for example, the Australian dollar rose by 10 per cent against the US dollar, the value of your investments in the US would fall by 10 per cent.

Over the long term though, does it really matter? 

Australian dollar outlook for 2023


The Australian dollar rose 1.1% to US69.6c on Tuesday, following the RBA rates decision with saw the cash rate rise to 3.35%. RBA governor Philip Lowe has signalled further rate hikes are on the way.

Westpac senior currency market strategist Sean Callow expects that momentum to continue, as rates continue to rise and the growth outlook improves in Australia’s top trade partner China.

“The case for further rate hikes, rather than a pause in the near term,” Callow says. Westpac economists expect the cash rate to peak at 3.85 per cent in the first half of the year.

While the stronger pace of rate rises from the US Federal Reserve pushed up the US dollar in 2022, markets are starting to factor in rate cuts from the US Fed by the second half of 2023, which would put downward pressure on the US dollar and upward pressure on the local currency, according to Westpac’s Callow.

NAB too sees the local currency stronger this year, rising to US78c by December this year and to US80 cents in 2024.

But not everyone agrees.

Commonwealth Bank thinks the Australian dollar will fall to US67¢ by the year’s end, so views from the experts are mixed.

Taking a bet each way on hedging


Currency hedged funds aim to remove foreign currency exposure on international investments, so the returns reflect the change in the underlying value of an investment.

In contrast, the return on an unhedged investment will be equal to the return on the foreign assets and movements in the foreign currency relative to the Australian dollar over the investment period.

“In recent years, more investors have acted to place a greater percentage of their portfolio in international assets, which means that investors must also consider whether they hedge their currency exposure,” says Alistair Mills, director of institutional business and capital markets at BetaShares.

Some investors are taking a bet each way and buying into both hedged and unhedged international share funds. There has been an increasing trend for fund managers to launch hedged options on unhedged international equity funds, giving investors a choice on hedging.

In 2022, the Vanguard MSCI Index International Shares Hedged ETF (VGAD) was the third most popular Vanguard ETF in terms of investor flows after the unhedged version of the same fund, VGS, according to Minh Tieu, Vanguard’s head of ETF capital markets, Asia-Pacific.

“In the fourth quarter of 2022, we also saw an uptick in flows into our Global Aggregate Bond Index Hedged ETF,” says Tieu. VGAD also attracted more flows than VGS during the fourth quarter.

“Demand for hedged products typically increases when market conditions seem particularly volatile. With the rapid increases in interest rates, the looming threat of recession, and ongoing geopolitical uncertainty, more investors may turn to hedged products in a bid to manage their global market and currency risks,” says Tieu.

However, while demand for hedged products was strong late last year, that demand has diminished in recent times given the Australian dollar’s recent climb over US$0.70, says VanEck head of investments Russel Chesler. It's since fallen back below that level.

“In the last quarter of 2022, when the Australian dollar was relatively week, flows into VanEck MSCI International Quality (Hedged) ETF (QHAL) exceeded flows into [the unhedged] VanEck MSCI International Quality ETF (QUAL). The Australian dollar hit a low of around US62c in mid-October 2022.

“With the Australian dollar having risen to above US70c in January 2023, we have seen a swing back to QUAL with only small flows into QHAL. It can be implied that investors are no longer seeing the Australian dollar as undervalued,” Chesler says.

BetaShares’ Mills says in the final quarter of 2022, BetaShares saw nearly $80 million in net flows to its Hedged Nasdaq-100 ETF (ASX: HNDQ). For context it’s unhedged version, the Nasdaq-100 ETF (ASX: NDQ) received over $110 million in net flows over the same period.

“A similar story is playing out with our BetaShares Global Sustainability Leaders ETF – Currency Hedged (ASX: HETH) and its unhedged version the Global Sustainability Leaders ETF (ASX: ETHI). Both funds received around $60 million in net flows over the final quarter of 2022.”

Depending on the fund manager, hedging can cost investors an additional fee of 5 to 10 basis points on top of the cost of an unhedged managed fund version. 

“An investor’s decision to hedge or not to hedge should be first and foremost dependent on their risk tolerance and individual preferences,” Vanguard’s Tieu said.

“Foreign exchange rates are notoriously difficult to predict, and the value of the Australian dollar can be affected by a lot of different factors so using hedging as a way to generate returns can be unfruitful. For investors looking to employ a hedging strategy, ETFs are a cost-effective way to do so.”

Does hedging matter?


According to VanEck senior associate, Alice Shen, the decision whether to hedge your international equity portfolio can impact your investment over the short and medium term,  currency impact over the long term is negligible.

"It’s important to remember over the long run, currency risks even out – what goes up, must come down – and currency volatility is smoothed out," Shen says in an article on FirstLinks.

"The total return from currency for the calendar years from 1997 to 2022 is -0.03% p.a. Over that same time the index has returned 10.34% p.a. In other words, over a long-term period of nearly 26 years the decision to hedge or not hedge your international equities investment would have had a negligible impact on your overall portfolio performance."