Dollar’s slide good for investors looking offshore
A fall in the Australian dollar magnifies returns when international assets are converted into local currency. Conversely, a rise in the Aussie would decrease returns.
The Australian dollar has hit a decade low at around US67 cents as world markets digest the coronavirus fallout.
The currency’s fall is boosting returns from unhedged offshore share investments, and some analysts suggest a slide towards US60 cents is possible given the spread of the virus, which had claimed 2000 lives by Wednesday.
A fall in the Australian dollar magnifies returns when international assets are converted into local currency. Conversely, a rise in the Australian dollar would decrease returns.
Experts are mixed on the Australian dollar’s longer-term direction, but most think a short-term dip is likely, which would favour unhedged international investments.
According to Drew Meredith, managing director at financial planning firm Wattle Partners, “the equation is quite straightforward. A falling Australian dollar increases the value of international shares [and] bonds … this relationship extends into Australian companies with primarily overseas earnings such as CSL (ASX: CSL), Resmed (ASX: RMD) or Orora (ASX: ORA), whose earnings become more valuable.”
Trent Loi, AMP Capital portfolio manager of the Specialist International Share Fund, says the fall in currency is good for those already invested in international share markets. However, for new investors, “the fall in the Australian dollar will translate to lower buying power for international investments.”
Loi says depending on one’s views on the currency, investors can generate additional returns by varying the hedged ratio for their international investments, with an unhedged position good when the dollar falls.
“The Australian dollar typically underperforms in a risk-off market environment. This can be good for currency unhedged investors as their loss in equity market could be offset by the gain via the Australian dollar’s fall.”
Australian dollar v the Greenback
Source: Morningstar Direct
On the other hand, hedging can play a part if you are a conservative investor and simply don’t want to expose yourself to any currency volatility. There has been an increasing trend for fund managers to launch hedged and unhedged options on international equity funds, putting the onus on the investor or their adviser to make the decision on hedging.
A common route being taken by investors is to take a bet each way on the currency and buy into both hedged and unhedged managed international share funds. The more conservative you are, the higher the ratio of hedged investments versus unhedged investments.
“We note that investors typically prefer the path of least regret by investing equally in a currency unhedged vehicle and currency hedged vehicle,” says AMP capital’s Loi.
Whether to hedge also depends on the investor’s long-term view of the Australian dollar against the particular currency of the country they are investing in, their risk profile and their timeframe.
“One of the most important considerations is the risk tolerance and return objective of each investor and whether they are willing to be exposed to such an unknown variable,” says Meredith.
However, John Abernethy, chief investment officer at Clime Investment Management, says currency is a secondary consideration and hedging should only be undertaken if the Australian dollar is perceived to be oversold given macro fundamentals.
“Normally, international investment should be undertaken in a diversified or balanced portfolio, the intention being to capture better growth opportunities and diversification to sectors that are superior to Australian opportunities.
"Currency is a secondary consideration and hedging should only be undertaken if the Australian dollar is perceived to be oversold given macro fundamentals,” says Abernethy.
Dollar could fall more near term
Whether the dollar is oversold depends on who you ask. According to the Commonwealth Bank, upside in the Australian dollar will remain limited. The local currency has underperformed the major currencies this year, a feature evident since the impact of the Australian bushfires, drought and the coronavirus.
The bank forecasts the currency to stay around current levels or fall given an expected fall in interest rates, which will make Australian investments such as bonds less attractive to offshore investors, causing a capital outflow from the country.
But a contrary view comes from Julien Tousignant, Economist at Hexavest, an Eaton Vance affiliate manager, who sees potential for the Australian dollar to be among the best-performing of G10 currencies for the rest of 2020.
“We expect the main drivers behind the appreciation of the Australian dollar to come from gradually improving global conditions, says Tousignant.”
“After the negative impact of the 2019-nCoV eases, we expect to see an acceleration in global economic growth, led by Asian economies. This should support a recovery in commodity prices to which the Australian dollar is closely linked.”.
Another factor to consider is the cost of hedging, which can sometimes add to the management cost of a fund, though not always.
Kris Walesby, chief executive of ETF Securities says: “Investors should consider their ability to manage currency risks in their overall portfolio, the costs of hedging which may affect their overall returns and the volatility of currency in the jurisdiction where the investments sit.
“For example, currency may move more in an emerging market compared to a more developed market like the US meaning it may be worth hedging to manage stability in your portfolio.”
