Written by Michal Park
Whilst the Australian dollar currency hovers at around 0.62USD, it has oscillated between 0.57 and 1.10 US dollars over the last 15 years. It reached a two-and-a-half-year low recently amid growing fears of global recession caused by high inflation, sharply rising interest rates, a European energy crisis, and the Ukraine crisis.
However, in a nutshell, the interest rate gap between here and the US makes the US much more attractive and therefore our currency loses favour. Only when the US Fed starts to slow the pace of their interest rate rises will our dollar start to become more attractive and strengthen.
So how can we turn this current negative into a positive? In simple terms, when the Aussie dollar is dropping against the USD, investors should keep their currency exposure unhedged and when the AUD is rising investors should hedge their currency exposure.
Whether to hedge or not reminds me a lot of trying to decide whether to fix residential mortgage rates or remain variable. In the shorter term it can make a difference (providing you got the outcome right!) but over the longer term, the difference between currency hedged and unhedged returns really does diminish and thus the effects of currency fluctuations are negligible.
The graph below illustrates differences between AUD currency hedged and unhedged annualised returns for US exposure represented by S&P 500 over various periods.
When deciding whether to currency hedge or not it is important to consider where you think the Aussie dollar is valued now relative to your end investment time. If you think AUD is at the lower end of the band, then you should hedge. If you think it is at the upper band, then you should remain unhedged so you get the benefit when it weakens.
FYI: unhedged currency international equity exposure has historically provided more diversification benefits, illustrated by having a lower correlation to Australian equity returns compared to international currency hedged exposure.
Ultimately, much like investing in equities, timing currency exposure is difficult to assess. Currency movements are unpredictable and volatile and are just one of the many risks we have to navigate when investing overseas. And as always, it is time in the market, not timing the market, that tends to prevail.