Fall in Aussie dollar could boost offshore asset values
Any decline towards US62c could further enhance the gains on offshore assets, which experts claim offer greater diversity than the limited choice of investments at home.
The lower Australian dollar is boosting the value of offshore investments and any decline towards US62c could further enhance the gains on offshore assets, which experts claim offer greater diversity than the limited choice of investments at home.
The Australian dollar has fallen to below US68c from US72.5c in January, and some economists expect it to fall towards US62c given expectations of further interest rate cuts. For investors holding offshore assets, their value has increased with the drop in the currency and that could continue to rise if it dips further.
For example, if the Australian dollar fell by 10 per cent, the value of offshore investments held in US dollars would rise by 10 per cent. Any rise in the local dollar diminishes returns when assets are converted into the local currency.
“An investor who believes that the Australian dollar is set to decline from current levels to US62c would see their US dollar denominated assets benefit from the currency move,” says Rob Holder, asset allocation and portfolio analyst at Crestone Wealth Management.
“From a portfolio standpoint investing offshore offers diversification benefits and would be expected to reduce overall risk.”
Reasons to go offshore
One of the big benefits of international investing is the diversity it offers. Charles Hamieh, senior portfolio manager at RARE Infrastructure, says Australian investors have a pronounced home bias when investing. Yet Australian shares represent only about 2 per cent of the global share market capitalisation.
“While this [bias] is understandable given our familiarity with local companies and the attraction of franking credits, it may compromise a portfolio’s ability to achieve its long-term objectives. Investors miss out on a world of potential opportunities from a universe of global opportunities across developed and developing markets,” says Hamieh.
“A larger global allocation vastly increases the flexibility available for investors to generate appropriate levels of total return.”
Investing offshore also means investors can access sectors and industries that are not well represented in Australia, including information technology. Kanish Chugh, co-head of sales at ETF Securities Australia, says the Australian market, for example, does not have many stocks in the robotics, automation and artificial intelligence industry, which is why Australian investors look to investment products such as international exchange-traded funds to broaden their portfolios.
“As ETFs have evolved and more options are brought to market, they offer investors the ability to diversify their portfolio away from Australia and into offshore markets, whether that be specific countries or regions,” says Chugh.
Yet the risks too of offshore investing may be greater than local investing. The key risks include, macroeconomic, market, political and regulatory risks.
“While regional diversification can reduce political risk, to mitigate other risk factors, it is important to ensure that portfolios are more broadly diversified. Examples of such diversification include across regulatory regimes as well as different economic environments,” says Hamieh.
Boost from the currency
Crestone’s Holder says currency movements represent a risk for offshore investments, but also an opportunity. Hedging can reduce this risk, but also limit gains.
“Some investors choose to avoid [currency] risk by hedging all or some portion of their foreign currency denominated assets while others believe that adding currency effects helps to reduce the overall risk of a portfolio.
This is because historically the Australian dollar has weakened at times of market stress, dampening the effects of falling asset prices. Conversely, the Australian dollar has tended to strengthen when risk assets are performing well, reducing overall returns from foreign assets,” he says.
“This can be seen when looking at 2008, when markets sold off sharply during the global financial crisis. The MSCI World Index ex Australia was down close to 40 per cent in Australian dollar terms on a hedged basis, but when you introduce the impacts of currency movements (on an unhedged basis) the Index was down approximately 25 per cent.”
Nicholas Cregan, portfolio manager and co-founder at Fairlight Asset Management, also believes currency movements can cushion a portfolio when share markets sell off.
Over the past 20 years, where there has been a greater than 5 per cent drawdown in the S&P 500 in any one month, the US dollar has delivered a positive return versus the Australian dollar during the same month in about 75 per cent of those instances.
“The weakness in the Australian dollar has historically provided a reasonably reliable buffer during significant risk-off events for Australian investors,” says Cregan.
“Whilst investing in global equity markets is not risk free, it is worth noting that an Australian investing in the unhedged MSCI World SMID index from 2007 to 2009 endured a 25 per cent lower drawdown than investing in the equivalent index domestically. Interestingly, the World SMID Cap Index also handily outperformed the Australian large cap equivalent over the same period,” says Cregan.
As for where the currency is headed next, Shane Oliver, chief economist at AMP Capital Investors, says the higher probability of further monetary easing in Australia points to more downside for the Australian dollar, though he believes much of the fall has already been felt.
“Our base case remains for the Australian to fall to US65c in the months ahead as the RBA eases further, but at the end of 2020 it’s likely to be stuck around US65c to US70c,” says Oliver.