Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn
About

News

Why hedging may make sense

Nicki Bourlioufas  |  02 Apr 2020Text size  Decrease  Increase  |  
Email to Friend

The dramatic fall in the Aussie dollar in March and the chance of an equally sharp bounce-back means some investors may be considering hedging their assets to reduce risk.

The Australian dollar hit a decade-low of around US55 cents on 19 March, as world markets digested the coronavirus pandemic and the imminence of global recession. The currency has since rebounded to 61.5 cents and jumped 7 cents in a single week, highlighting its volatility.

Local currency could gravitate higher over the remainder of the year. This means currency hedging makes sense for offshore investments, says Drew Meredith, managing director at financial planning firm Wattle Partners

“Once the Australian dollar moved under US60 cents, we engaged with every client to switch to hedged wherever possible. The dollar is now below historical averages and represents potential risk to those investing overseas,” says Meredith.

“Having experienced volatility at all-time highs, we would prefer to remove at least one risk (currency) from our portfolios and rely on the recovery of share prices from the underlying businesses."

A rise in the Australian dollar diminishes returns when assets are converted into the local currency. On the other hand, any fall helps investors. If the Australian dollar rose by 10 per cent, the value of your offshore investments would fall by the same margin.

Hedging makes sense if you think the Australian dollar is going to rise. It can also play a part if you're a conservative investor and simply don’t want to expose yourself to any currency volatility.

Many analysts expect the Aussie dollar's value to move around this year, as the coronavirus runs its course and the global economy remains stalled.

Hedging isn't without risks

Assuming that stock prices have hit their nadir and that the Australian dollar has troughed is the main risk, says Simon Doyle, head of fixed income and multi-asset at Schroders.

While both assumptions may be correct, there may also be further downside as the economic realities of shutting down the global economy hits corporate profitability.

“In this environment further weakness in the Australian dollar is probable and this would help offset any further equity weakness … [I] would not be surprised if it falls below US50 cents before this cycle is over,” says Doyle.

“On the basis that it is difficult for individual investors to really manage their currency exposure a more blended approach might be preferable."

Jun Bei Liu, portfolio manager with Tribeca Investment Partners, says Australia's close economic ties with China mean our dollar has long been used as a barometer for global growth.

“While the world continues to combat Covid-19 through forced shutdown and supressed consumption, the Australian dollar is likely to remain volatile,” says Liu.

She expects a flight to safe haven assets or currencies such as the US dollar, but says the suitability of such approaches depends on how much risk your portfolio can handle.

"Currency movements will make the underlying investment return more volatile; in some cases, it may double or erase the entire investment return,” says Liu.

"If investors don’t have a strong view of the currency direction, then a hedged option would definitely provide smoother returns."

Hedging your hedge

Gemma Weeks from ETF Securities says it's impossible to predict how low the Australian dollar will go. And she agrees with Bei Liu's view that the US dollar probably holds more appeal given the volatility of markets at the moment.

But for investors keen to buy the local dollar she suggests another approach.

“After seeing the Australian dollar swing after market crashes before, many investors will still want to take a hedged position at this time. If so, so why not hedge your hedge?" says Weeks.

"By switching 50 per cent of your position into hedged and leaving 50 per cent unhedged, you're essentially mitigating any currency risk, giving investors the best of both worlds."

Over the long run, experts say that currency risks even out – what goes up, must come down – and currency volatility is smoothed out. But if you do decide to hedge now, there may be a small of between 2 to 10 basis points compared to an unhedged version of the same managed fund.

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. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. 

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend