Riding the Australian dollar wave

The Australian dollar has been on a ride. In early August, it fell to a low, buying $0.6498 US dollars due to declining commodity prices and concerns about a potential US recession. By mid-August, it has risen to a high of $0.6745, as recession fears eased and the RBA reaffirmed the low chance of rate cuts this year.

Currency fluctuations impact the value of Australian investors’ assets held offshore. For this reason, many investors choose to hedge their portfolio exposure.

To hedge to not to hedge? If Hamlet was an international equities investor, that may have been what he would have asked.

Currency hedging international exposures

The decision to hedge your currency exposure is important because movements in the Australian dollar can either erode or add value to your investment. For example, 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 per cent, all other things being equal, the value of your offshore investments would rise by 10 per cent. However, the converse is true and any rise in the Australian dollar diminishes returns when the value of 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 Aussie dollar vs USD on the value of international equities since before the GFC. As the Australian dollar (black line) appreciated into 2008/09 hedged international equities (light blue line) outperformed. When the AUD fell sharply from April to August 2013, unhedged equities (dark blue line) benefitted significantly while hedged equities gained only from underlying stock performance. As the Australian dollar depreciated further in 2014/15 hedged international equities continued to gain due to underlying stock performance but unhedged equities gained more. In March 2020, you can see that the value of hedged international equities fell much more sharply, versus the unhedged equities because these were cushioned with the simultaneous collapse of the Australian dollar.

What history shows us

In August, the value of the Australian dollar has been influenced by concerns over a potential US recession, changes in expectations for the RBA cash rate, and Australia’s economic ties to China, particularly regarding demand for commodities. Other drivers of the value of a currency include interest rates and the country’s creditworthiness. Australia has a high credit rating, but its interest rates could be moving in a different direction to other developed market central banks. It is for this reason many currency investors are speculating that the Australian dollar could continue to move.

For example, while the market expects the US Federal Reserve to start cutting before the end of the year, this is not a certainty. Conversely, the RBA is working to keep high rates on hold to tackle sticky inflation. The future is unclear, even the immediate future.

That’s why we think it’s important to remember that over the long run currency risks generally even out.

This can be demonstrated by looking at the long-term returns of an international equities fund. As an example, Chart 2 below shows the long-term returns for the unhedged index tracked by our popular VanEck International Quality ETF (ASX: QUAL)

The total return from currency for the calendar years from the start of 1997 to June 2024 is 0.08% p.a. Over that same time the index has returned 10.26% p.a. In other words, over a long-term period of 27 and a half 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 we saw in Chart 1 above and can see in many of the calendar years in Chart 2 where the light blue contributes (or detracts) returns.

Exceptions to the rule

While long-term equities investors have the timeframe to withstand currency fluctuations, it is a very different story for investors who rely on regular income from their portfolio and whereby currency movements can have an almost immediate and undesirable impact. This is why a currency-hedged approach to asset classes traditionally associated with income, such as global infrastructure e.g. (ASX: IFRA), international property e.g. (ASX: REIT) and global listed private credit e.g. (ASX: LEND), is ideal. This hedging ensures income generated offshore is not offset by currency movements.

Conversely, when investing in gold, an unhedged approach may make more sense as there is low correlation between the price of gold and AUD/USD price movements. Because the two are uncorrelated there is no investment rationale to hedge your gold and gold miners exposure back to Australian dollars.

Opportunities on ASX

VanEck has a range of hedged and un-hedged international equities ETFs that allow investors to position their portfolio according to their views on currency movements. The decision to manage currency exposures can also be made through a blend, e.g. 50% hedged and 50% unhedged. Find out more about how you can invest in our ETF's here.