Currency shines in brighter future

Economic expectations revealing positive future prospects for the Australian dollar, along with the arrival of currency hedged funds, could mean international currency investing may soon experience its time in the sun.

It marks a huge turnaround from the currency roller coaster of the past, which saw the Australian dollar fall heavily in the past three decades against most major currencies.

Just a little more than a year ago, the Australian dollar began a steep decline, reaching all time lows in response to global events and a very strong US dollar.

But the recent revival of the Aussie dollar, and the expectation that it will continue to increase, has now raised awareness of the impact that an appreciating Australian dollar could have on returns from global investments.

Further, the arrival of products enabling currency risk to be managed more effectively may also help.

“Now, with the Australian dollar increasing, the issue of currency risk is moving to the front of investors’ minds,” Merrill Lynch Investment Managers (MLIM) Quantitative Analytics director Ken Liow says.

Investors are now recognising the diversification benefits of international investing and want to increase their exposure to global markets, but do not necessarily want all the foreign currency exposure that would come with it.

Where in the past retail investors have held back from embracing a large exposure to international equities due to the limited control of managing currency risk, the development of currency hedged funds could be the beginning of a turnaround in the popularity of global equity investing.

“If there was no currency risk, investors would have less in Australian equities and more offshore. But up to this point, the retail market, unlike the institutional market, has not been able to do much about it,” Liow says.

The emergence of currency hedged funds means a client’s investment in international equities can be protected against currency appreciation by locking it in at a predetermined exchange rate. Currency hedged funds use a number of different strategies to do this, the most popular of which, according to Liow, is Forward Foreign Exchange (FFX) contracts.

MLIM launched two global funds in March last year, the ML Global Titans Fund and ML Global Small Caps Fund, which are offered in both hedged and unhedged alternatives. The hedged alternatives have already proved popular with investors — with a large proportion of inflows directed into the hedged alternatives, Liow says.

The use of currency hedged funds for investing in international equity portfolios is also proving more attractive to advisers as they identify the ability to greater diversify their client’s portfolios without any increase in currency risk.

"These products allow you to separate the decision to invest internationally and to manage currency risk," Liow says.

The popularity of foreign investing and currency hedged strategies looks set to take off, and looking ahead Liow says a continued increase in offshore investing and subsequently greater diversification, is expected.

For example, if a typical portfolio has 40 per cent exposure to Australian equities and 20 per cent in international, the future will see a more evenly balanced portfolio of 30 per cent in both Australian and international equities.

Of the additional 10 per cent in international equities, Liow says it is likely a large proportion will be invested through a currency hedged vehicle.

"In the next three to five years, currency hedged international equity investments will be mainstream and a normal part in any investment portfolio, as the retail market realises you can separate currency management and international equity exposure and the degree of flexibility it offers," Liow says.

AMP Henderson Foreign Exchange manager Chris Loong also says the impact of currency movements on Australians investing money offshore is currently a hot topic.

"An increasing amount of Australian money is being invested overseas, particularly in global equities. These investors are understanding the good opportunities offshore in terms of returns and diversification," Loong says.

He says a marked increase in the global equity weighting of portfolios can be seen since about five years ago, with figures roughly suggesting the proportion has lifted from about 15 per cent to the current 24 per cent.

With the traditional unhedged currency product, Loong says in the past investors have been happy to take the foreign currency exposure, particularly over the long term.

But more recently, with the development of hedged currency products, Loong says the question must be asked whether this reflects a view on the direction of the currency or a change in attitude to currency risk.

The fund manager's current approach is active discretionary hedging, where the fund can be partly hedged at the manager's discretion.

"If we have the view that the Australian dollar will increase, you can partly hedge the portfolio, so we can add significant value," Loong says.

But in view of the economic outlook for the Australian economy, Loong says the development of a passively hedged product is a possibility.

"The current AMP house view is that the Australian dollar will increase for most of the year based on the outlook for the global economy and the US dollar entering a significant down trend after sustained appreciation in recent years."