Hedging currency risk more popular on lower dollar
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Nicki Bourlioufas is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.
If you're planning to invest in offshore assets, then the decision about whether or not to hedge your currency exposure is an important one as movements in the Australian dollar can either erode or add value to your investment.
Any drop in the Australian dollar helps investors as it magnifies gains when assets are converted into local dollars. So if, for example, the Australian dollar fell by 10 per cent, the value of your offshore investments would rise by 10 per cent.
However, any rise in the Australian dollar diminishes returns when assets are converted into the local currency.
So, should you be investing in hedged or unhedged investments, or a bit of both? It's an important question as Australian investors are increasingly investing offshore in order to diversify their portfolios into different asset classes and geographic regions.
For example, if you want a decent exposure to the technology sector, then you really need to be invested in the US share market to gain exposure to the world's biggest IT companies such as Alphabet (Google's owner), Microsoft and Apple.
But if you do invest in the US or elsewhere, should that international investment be exposed to currency risk, or should it be hedged against the risk of the Australian dollar rising, which would eat into your returns?
According to Andrew Lord, director of wealth management with HLB Mann Judd, strong gains in the currency are less likely over the short to medium term given the depreciation of the Australian dollar versus the US dollar has likely run its course.
"There may be a little more on the downside, but not a lot. As the currency has fallen, we've moved from being unhedged to having more hedged investments--the easy money on the currency has probably been made," Lord says.
For that reason, Lord has about 50 per cent of investments in the US hedged, while he opts to leave about 50 per cent unhedged, noting that over the past 10 years returns on the MSCI World Net Index are the same in US dollars and Australian dollars, suggesting the currency is sitting somewhere around long-term fair value.
Financial adviser Bruce Brammall says his clients are now sitting in hedged international share index funds.
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