Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 484

To hedge or not to hedge?

The decision whether to hedge your international equity portfolio can impact your investment over the short and medium term, but an analysis of the data shows that currency impact over the long term is negligible.

Currency hedging international exposures

The decision to hedge your currency exposure is an important one as movements in the Australian dollar can either erode or add value to your international investment. Any drop in the Australian dollar helps unhedged investors as it magnifies gains when assets are converted back into Australian dollars. So if, for example, the Australian dollar fell by 10%, all other things being equal, the value of your offshore investments would rise by 11%.

However, the converse is true and any rise in the Australian dollar diminishes returns when foreign investments are converted back into Australian dollars. This is where hedging an international portfolio may be advantageous, as it will benefit from rises in the value of the Australian dollar.

The chart below shows the impact of movements in the AUD vs USD on the value of international equities over the past 15 years. As the Australian dollar appreciated into 2008-09, hedged international equities outperformed. When the AUD fell sharply from April to August 2013, unhedged equities benefitted significantly while hedged equities gained only from underlying stock performance.

As the AUD depreciated further in 2014-15 hedged international equities continued to gain due to underlying stock performance while unhedged equities gained more. Finally in March this year, you can see that the value of hedged international equities fell much more sharply and in line with the broader market crash, versus the unhedged equities which were cushioned with the simultaneous collapse of the Australian dollar.

Chart 1: Australian dollar and hedged and unhedged international equities returns

Source: Bloomberg, 1 January 2002 to 30 September 2022. Unhedged International equities is MSCI World ex Australia Index. Hedged International equities is MSCI World Ex Australia 100% Hedged to AUD Index. You cannot invest in an index. Past performance is not a reliable indicator of future performance.

AUD/USD fell below 50 cents back in 2001

When the Australian dollar tested lows before, in 2001, 2008, and the Covid crisis it was different from the current rate environment. At US$0.67, it currently is a long way from those depths.

Back in 2001, times were different. Monetary policy was orthodox, and the RBA cash rate was high. In 2008, Australia went into the GFC with among the highest cash rates in the developed world and avoided the need for unorthodox policy.

Now there is a range of different factors to consider including the fallout of the unorthodox monetary policy that was implemented in the wake of the Covid crisis, the global recovery and associated supply shocks from COVID-19, the deleveraging of government balance sheets, the Fed’s rapid rate rises in the face of 30-year high inflation and Australia’s lower cash rate relative to other crises. During the current RBA rate rising cycle, the Australian dollar is not appreciating as it has during past hikes (2002 to 2008, and 2009 to 2010).

Chart 2: Australian dollar and the RBA cash rate

Source: Bloomberg, 1 January 2000 to 30 September 2022.

To hedge or not to hedge a Quality international equity exposure

This year's fall in the Australian dollar has led investors to ponder: should they be investing in hedged or unhedged international investments, or a bit of both?

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. Chart 3 below shows the long-term returns for the unhedged index tracked by QUAL.

Chart 3 Calendar year breakdown of MSCI World ex Australia Quality Index’s returns

Source: MSCI. Annual returns to end of each calendar year data. 2022 is to 30 September 2022. Past performance is not indicative of future results.

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. For short to medium term investors, the decision becomes more important as can be seen in blue in the chart above in which there are fluctuations from year-to-year.

It's impossible to predict markets and the same could be said of currencies. As always, we recommend talking to a financial professional to determine which currency strategy is right for you.

 

Alice Shen is a Senior Associate, Investments & Capital Markets at VanEck, a sponsor of Firstlinks. Any views expressed are opinions of the author at the time of writing and is not a recommendation to act. This is general information only and does not take into account any person’s financial objectives, situation or needs. Investors should do their research and talk to a financial adviser about which products best suit their individual needs and investment objectives.

Key risks
An investment in QUAL carries risks associated with: ASX trading time differences, financial markets generally, individual company management, industry sectors, foreign currency, country or sector concentration, political, regulatory and tax risks, fund operations and tracking an index. See the PDS for details.

For more articles and papers from VanEck, click here.

 

4 Comments
Doug Turek
November 16, 2022

I think this is an important article but the conclusions might be understated. While I guess the decision to hedge or not over 26 years might be negligible on returns, I suspect investors would find hedging when the A$ post a crisis was particularly weak adds value, just as no hedging might when it is particularly strong (eg. mining boom, 2000 dot com US weakness) ... this assuming or observing currency mean reverts over time. On volatility, since the A$ is also a risk off currency, there is an argument that less or no hedging contributes to lower volatility for local investors in offshore shares. As pointed out, unhedged Int'l equities are down less today in a beaten down A$ (but that excess relative return you'll give back if you don't turn hedging on for/if the A$ recovers, US$ weakens). It is arguable currency is an asset class in its own right and investors might wish to treat it so using hedged or unhedged funds more purposefully and/or some of the currency ETFs available. Lastly, given that share markets and the A$ often go down together in a crisis, it would be interesting to see a finally yielding now, unhedged US$ high quality / Government bond ETF made available on the ASX. It might have two reasons to go up and protect an equity portfolio in the next crisis.

asdf
November 18, 2022

Lastly, given that share markets and the A$ often go down together in a crisis, it would be interesting to see a finally yielding now, unhedged US$ high quality / Government bond ETF made available on the ASX. It might have two reasons to go up and protect an equity portfolio in the next crisis

Good thought.

Rob
November 16, 2022

One glaring omission from this discussion - matching Assets with Liabilities. If all, or most of your future Liabilities are in Aussie $'s, any unhedged investment is adding yet another variable to the investment mix.

May be a hero or a dunce, just understand the risks!

Warren Bird
November 22, 2022

There's something very important missing from this article. Hedging back into the A$ has almost all the time earned an income premium for Australian investors. Thus, although the A$ has not generated a net return (-0.03% cited in the article), which means that investors would have earned the unhedged return from overseas shares, you need to be aware that if you'd invested in a hedged vehicle you'd have earned those local market returns PLUS the additional income return.
(I wrote about how this comes about here: https://www.firstlinks.com.au/managing-foreign-exchange-risk)

Of course, that historical outcome doesn't mean that hedging into the AUD will always generate a premium. At the moment it would do the opposite, with interest rates higher in many other countries than here (eg US Fed Funds at 4% versus our 2.85%, and a similar differential extending out the yield curve). But it's a critical part of the decision about hedging or not that's been left out of this discussion.

Rob makes a valid point about needing to consider whether hedged or unhedged delivers appropriate Asset-Liability matching. How I wish more investors would think of their strategies in that way! (They do in a partial sense by thinking about investment time horizons, but far too many still focus on the short term not the long term.) In that context, I'd argue that the unhedged exposure you take - that is, how exposed your portfolio is to the volatility of currency - needs to be looked at as part of your long term assets, the bit of your portfolio that you are leaving there for 20 or 30 years. Currency will contribute volatility during those 20-30 years, but the value you can realise to meet your expenses in a few decades should still have grown by a decent amount with little total impact from the exchange rate. So, having all your expenses (liabilities) in A$ doesn't necessarily mean you would have no unhedged overseas exposure.

 

Leave a Comment:

     

RELATED ARTICLES

Currency hedging for international equity portfolios

Four ways to determine your international equities allocation

Does currency hedging provide an edge?

banner

Most viewed in recent weeks

An important Foxtel announcement...

News Corp's plans to sell Foxtel are surprising in that streaming assets Kayo, Binge and Hubbl look likely to go with it. This and recent events in the US show the bind that legacy TV businesses find themselves in.

Welcome to Firstlinks Edition 581 with weekend update

A recent industry event made me realise that a 30 year old investing trend could still have serious legs. Could it eventually pose a threat to two of Australia's biggest companies?

  • 10 October 2024

The quirks of retirement planning with an age gap

A big age gap can make it harder to find a solution that works for both partners – financially and otherwise. Having a frank conversation about the future, and having it as early as possible, is essential.

Welcome to Firstlinks Edition 578 with weekend update

The number of high-net-worth individuals in Australia has increased by almost 9% over the past year, and they now own $3.3 trillion in investable assets. A new report reveals how the wealthy are investing their money.

  • 19 September 2024

The everything rally brings danger and opportunity

Most market players today seek quick rewards and validation of opinion. Outsiders willing to combine new technology with old-fashioned patience and focused analysis can prosper.

Creating a bulletproof investment portfolio

Is it possible to build a portfolio that performs well in any economic environment? So-called 'All Weather' portfolios have become more prominent of late, and this looks at what these portfolios are and their pros and cons.

Latest Updates

Retirement

The quirks of retirement planning with an age gap

A big age gap can make it harder to find a solution that works for both partners – financially and otherwise. Having a frank conversation about the future, and having it as early as possible, is essential.

The everything rally brings danger and opportunity

Most market players today seek quick rewards and validation of opinion. Outsiders willing to combine new technology with old-fashioned patience and focused analysis can prosper.

Investment strategies

Portfolio construction in the real world

Building a portfolio is like building a house. This framework can help you move towards your goals without losing sight of reality or leaving yourself vulnerable to market storms.

Shares

Feel the fear and buy anyway

In this extract from his new book, the co-founder of Intelligent Investor reveals how investors can avoid critical mistakes and profit from opportunities in collapsing share prices.

Investment strategies

The risks of market concentration and not staying invested

MFS chief investment officer and CEO elect Ted Maloney talks market risks, similarities between Trump and Harris, and the most important thing investors can do to avoid destroying value.

Gold

Gold's important role as geopolitical tensions rise

Equity markets have traditionally struggled at times of sustained geopoltical tension. Gold, on the other hand, has thrived and can provide investors with protection against "unknown unknowns".

Strategy

The changing face of finals footy and the numbers behind it

A well-meaning AFL rule change in 2016 seems to have had unintended consequences. The top teams might cry foul but AFL bosses are unlikely to be too miffed about the outcome.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.