The Hyperion Effect

Posts Tagged ‘Currency Speculating’

I keep reading with much interest the almost daily prognostications on the Australian dollar and whether it will continue to go up, will settle back down to parity or even revert back to longer term levels in the $0.60c and $0.70c area. A strong dollar has benefits for Australians through lower prices for imported goods and a significant reduciton in the cost of travelling overseas. The downside of course is that it makes it much more difficult for our exporters to be sucessful and the relative atractiveness of Australia as a travel desitination is somewhat dimiished.

From an investment perspective we take an agnostic approach which is why I was interested in an article in the paper recently that quoted some retirees saying that they were concerned about their retirement due to the effect the dollar has had on their international investments.

 This is great cause for concern to me as the dollar should have no impact on a decision to retire and whilst it will always inmpact the net returns recieved from an international allocation it should have no significant impact unless you are engaging in currency speculation.

What do i mean by this?. Put simply if you are investing overseas with no protection against the dollar you are betting that its value will fall relative to where it was at the time you invested. Conversely if you are fully protected against it you are betting that it is going to be higher realtive to when you purchased and are paying a fee to protect against this. Both of these positions require you, or your adviser, to have some type of insight into which way they think the dollar will go. Speaking as an adviser myself I have absoloutely no idea which way its going. I can see the merits in both sides who argue that it will rise and fall but personally I have no idea.

Whilst you may think its my job to know this, the reality is that (a) I can’t possibly predict the future and therefore know where its going; and (b) actually its not my job to speculate with other peoples money. We therefore ensure that when we invest globally for clients (I will write a piece about why everyone should do this as part of a balanced portfolio) we protect 50% of the portfolio and leave the other 50% unprotected. This allows our clients to be both protected against movements in the dollar, whilst at the same time minimising the costs associated with buying protection. (known as hedging).

How does this work in practice?. By way of example we use two key international funds to deploy client moneis overseas into a broad basket of index based investments that essentially track the asset classes  of large, small and value stocks around the world. These two funds can be purchased in both an unhedged form (and subject to change from the rise and fall of the dollar) or in a hedged form (and not subject to the rise and fall of the dollar).

To the end of May this year the 1 year compound returns on each of these funds has been 1.09% and 16.09% respectively. Clearly over the past 12 months having the investments hedged has paid off as the rise in the dollar has had no effect on the strong returns generated in the global markets. The unhedged version didn’t fair so well, but is still positive, telling us that the returns generated have bascially been offset by the rise in the dollar. Overall however the client has recieved an effective return of around 9% (50% of 1.09% + 50% of 16.09%) despite the dollar movement. Had we as advisers been lucky enough to guess that the dollar would keep rising we could have made more, but converesely we could have bet on the fall of the dollar (which many are starting to do now) and our clients would have missed out.

If you are truly a smart investor, changes in the Australian dollar should have zero impact on your decsions about retirement and you should be cautious about betting either way as it can move rapidly and somtimes without warning.