Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 273

The positive FX hedge returns have now gone

Not many investors realise that a decent chunk of their US equities and fixed-income performance over the last 20 years has come from the benefit of hedging, and had nothing to do with the assets' underlying returns.

According to CBA research, hedging your US shares or bonds into Aussie dollars increased your returns by 4% per annum over this period. That is to say, you were paid to hedge, rather than hedging imposing a cost. For lower yielding asset-classes like fixed income, this made a big difference to the realised outcomes.

Between 1999 and 2018, US treasury bonds yielded only 3%, but by hedging into Aussie dollars, the yield increased to 7% while also reducing realised volatility significantly.

Tailwind becomes a headwind

Now the big deal is that this tailwind, which reflected the fact that the RBA’s cash rate was historically situated well above the Fed’s cash rate, has reversed as the Fed has embarked on its hiking cycle.

The chart below shows precisely how this dynamic has changed since 2011. The lower black line is the annualised yield on a US treasury bond while the upper grey line shows the same asset hedged back into Aussie dollars. Observe that in 2011, a US treasury yielding 2.5% morphed into a nearly 7% yield for hedged Aussie investors. The red dotted line represents the benefit or cost from hedging at any point in time.

Click to enlarge

Whereas in 2011 local investors picked-up a return uplift of as much as 4.5% hedging US assets into Aussie dollars, that advantage has fallen away over time to the point now where the red dotted line is slightly negative. In 2018, a 2.94% yielding US treasury paid only 2.86% in Aussie dollars.

Understand the cost or benefit of a hedge

This comes back to the principle known as 'covered interest parity'. If you own a US asset and want to hedge it back into Aussie dollars, the cost will normally reflect the interest rate differential between the two countries for the relevant maturity. For example, if the RBA’s cash rate is above the Fed’s, you should receive additional returns and vice versa.

In practice this relationship can be distorted if there is excess demand or supply for either currency, which can generate a cross-currency 'basis' under which you receive or pay more for the hedge than covered interest parity would otherwise imply.

The Reserve Bank of Australia has been capitalising on this dynamic for years, hedging billions of dollars worth of Japanese government bonds into local currency. While the Japanese bonds have carried a negative yield, hedged into Aussie dollars they deliver a handsome return above many other government bonds because of both the local interest rate differentials and the attractive cross-currency basis the RBA has earned.

It becomes important to recognise this when undertaking long-term performance analysis. I recently saw a presentation for a new, predominantly US high-yield fund that contained historical yields and returns hedged into Aussie dollars over the last five years. The annual yield enhancement from hedging US dollars into our currency over this period was about 1.4%, which is no longer present.

With this benefit the US high yield product outperformed Aussie high yield by 1.3% in total return terms, albeit that US high yield had much higher volatility (4.7% versus 2.8%). But this might not be true going forward as the Fed’s cash rate has risen above the RBA’s equivalent.

Something that appears superficially attractive might be a hedging mirage that has subsequently evaporated. This is, of course, a generalised statement and one should evaluate every investment on its merits on a case-by-case basis and ideally seek the counsel of trusted advisers.

And it is not just about outright returns. Many asset classes, including US high yield, can play a valuable role in portfolios if they are less than perfectly correlated with your existing assets and therefore furnish diversification gains.

 

Christopher Joye is a Portfolio Manager with Coolabah Capital Investments, which invests in fixed income securities including those discussed by this article. This article does not address the individual circumstances of any investor.

 

RELATED ARTICLES

3 reasons the Aussie dollar has not collapsed

Does currency hedging provide an edge?

Is the best value for Australian credit not in Australia?

banner

Most viewed in recent weeks

Australian house prices close in on world record

Sydney is set to become the world’s most expensive city for housing over the next 12 months, a new report shows. Our other major cities aren’t far behind unless there are major changes to improve housing affordability.

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

Tariffs are a smokescreen to Trump's real endgame

Behind market volatility and tariff threats lies a deeper strategy. Trump’s real goal isn’t trade reform but managing America's massive debts, preserving bond market confidence, and preparing for potential QE.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Getting rich vs staying rich

Strategies to get rich versus stay rich are markedly different. Here is a look at the five main ways to get rich, including through work, business, investing and luck, as well as those that preserve wealth.

Latest Updates

SMSF strategies

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Superannuation

The huge cost of super tax concessions

The current net annual cost of superannuation tax subsidies is around $40 billion, growing to more than $110 billion by 2060. These subsidies have always been bad policy, representing a waste of taxpayers' money.

Planning

How to avoid inheritance fights

Inspired by the papal conclave, this explores how families can avoid post-death drama through honest conversations, better planning, and trial runs - so there are no surprises when it really matters.

Superannuation

Super contribution splitting

Super contribution splitting allows couples to divide before-tax contributions to super between spouses, maximizing savings. It’s not for everyone, but in the right circumstances, it can be a smart strategy worth exploring.

Economy

Trump vs Powell: Who will blink first?

The US economy faces an unprecedented clash in leadership styles, but the President and Fed Chair could both take a lesson from the other. Not least because the fiscal and monetary authorities need to work together.

Gold

Credit cuts, rising risks, and the case for gold

Shares trade at steep valuations despite higher risks of a recession. Amid doubts that a 60/40 portfolio can still provide enough protection through times of market stress, gold's record shines bright.

Investment strategies

Buffett acolyte warns passive investors of mediocre future returns

While Chris Bloomstan doesn't have the track record of his hero, it's impressive nonetheless. And he's recently warned that today has uncanny resemblances to the 1990s tech bubble and US returns are likely to be disappointing.

Sponsors

Alliances

© 2025 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.