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Currency, for most investors, has always been a topic that causes consternation.
While many investors recognise the diversification value that international investments can bring, the fact that, by definition, such investments bring with them currency considerations adds an additional element to the decision. There is no doubt that managing the currency risk that comes with international assets can be a rather complex area. With the growing number of exchange traded products providing investors with easy access to international exposures on the ASX, currency becomes an increasingly important consideration as investors look to create diversified portfolios.
To hedge or not to hedge?
Currency fluctuations can dramatically affect the returns on international investments, both positively and negatively. As an example, should the Australian dollar rise against the USD, any investment returns from a US dollar based investment would be reduced as they are converted back into AUD. Conversely, should the AUD fall against the USD, any returns from US dollar based investments would be increased.
A hedged investment vehicle aims to remove the impact of currency movements, so that any changes in investment returns are being driven only by a movement in the value of the underlying assets. Hedging is usually conducted by “locking in” an exchange rate for the future using derivative contracts.
Determining whether you should be hedged or unhedged will be based on several factors, such as;
- Desire to take on currency exposure – hedging or partially hedging a portfolio can remove or diminish the currency risk that is inherent in international investments
- Timeframe – the longer your investment timeframe, the more willing you might be to accept the ups and downs that come with unhedged investments
- Tactical Views – an investor who has a tactical view on the direction of currency may base their decision on their own personal beliefs about where the market is headed
- Portfolio Design – the mix of defensive/growth assets may play a role in deciding whether or not to hedge. More defensive international assets are generally included in a portfolio to “buffer” declining markets, and currency movements could erode the value of these defensive assets when they are most required. It is also generally viewed that unhedged global equities are less correlated to Australian equities and as a result may enhance portfolio diversification
- Cost – hedging is a cost that is born by the investment vehicle and the costs of hedging may offset some of the gains that are accumulated.
Currency movement factors
Currency movements are notoriously hard to predict and can be driven by several factors. Some of these include:
- Interest rate differentials – one country’s higher interest rates may attract flows of money from other countries, strengthening the home currency
- A country’s current account deficit – a country spending more of its currency on importing products than what it receives on its exports will tend to face a declining currency
- Government debt – a country with high levels of debt is likely to see its currency decline as foreign investors will sell their bonds in the open market
- Political stability – a country with more stability is seen as less risky for foreign investors, which entices capital away from other countries. This will potentially increase a ‘stable’ country’s exchange rate.
BetaShares offers a broad range of international exposures – both hedged and unhedged. Furthermore, if you are invested in international securities on an unhedged basis, but believe hedging a portion of your portfolio may be beneficial, or simply have a strong conviction in the direction of currency, there’s an alternative to selling your assets and reinvesting in a hedged investment. One simple way investors can gain exposure to the benefits of currency hedging is through Currency exchange traded products. For example, BetaShares’ Currency exchange traded products provide investors with a simple, cost-efficient way to seek to profit from, or protect their portfolio against, changes in currency. The Currency ETFs are designed to provide a convenient way to gain exposure to the movement of currencies against the Australian dollar. For example, by using the BetaShares U.S. Dollar ETF (ASX: USD) a positive return can be generated if the U.S. dollar rises relative to the Australian dollar (and vice versa). Other currency ETFs that are offered by Betashares include a British Pound ETF (ASX: POU) and Euro ETF (ASX: EEU). Additionally BetaShares also has a fund offering geared exposure to the performance of the Australian Dollar’s performance relative to the U.S. Dollar (ASX: AUDS*) and another providing geared exposure to the U.S. Dollar’s performance relative to the Australian Dollar (ASX: YANK*).
* Gearing magnifies gains and losses and may not be a suitable strategy for all investors.