Published NOVEMBER 02, 2011 in AUSTRALIAN-ECONOMY - comments

My previous blog suggested that the AUD/USD would likely settle somewhat and move back below parity over the medium term. The AUD/USD has had a rollercoaster ride over the past couple of months, moving above 1.10 for a short period and recently plunging below 0.94, before rallying back to around 1.04 as I write!

This is extraordinary volatility which is caused by higher-than-normal global economic uncertainty.

Protecting (hedging) your International Equity investments against a volatile Aussie dollar

For an Australian investor, there is the risk that the capital value of their International Equity investment will fluctuate due to movements in the exchange rate, as the value of foreign currency is converted into Australian dollars.

For example

AUD/USD is at parity on 1 September therefore $100.00 AUD converted to USD = $100.00 USD

AUD/USD is at $1.05 on 1 October therefore when we convert the $100.00 USD back to AUD you will receive $95.24 AUD (100 divided by 105).

Investing in a hedged international equity managed fund will remove the currency risk. This is possible as the fund manager will effectively eliminate the currency exposure by obtaining forward positions in the derivatives market. Put simply, the forward positions will ensure that any movements in the currency are ‘cancelled out’ and there is no net currency gain or loss associated with the investment.

Hedging in the current economic environment

Over the longer term the returns on international equities are determined primarily by the performance of offshore companies, rather than exchange rate movements, and many analysts believe that maintaining a position (either hedged or unhedged) over the long term is a prudent strategy.

Over the shorter term, as we have recently seen, exchange rate volatility can have a material effect on returns. Given the current environment and volatile exchange rates, hedging can be a useful strategy to help manage your portfolio risk. In particular, if you have an exposure to international equities and your investment timeframe is short to medium term (say 1-5 years), it may be worth considering hedging at least some of your exposure.

Hedging does come at a cost, with fund managers usually charging a slightly higher management fee than would otherwise be applicable to similar unhedged investments.

There are many hedged international equity funds available, and should you wish to obtain further information or would like us to assess whether a hedging strategy may be appropriate for your circumstances, please feel free to contact our office.

Important: A full assessment of your personal circumstances and objectives is required to ascertain whether a hedging strategy is appropriate for you. The information contained in this blog is based on the author’s general opinion only and should not be considered as financial advice.