Currency: hedging your bets

Australians are making the most of the strong Aussie dollar and rushing to make major overseas purchases like holiday homes and luxury boats, according to Renee Doughty.

There has been a marked increase in the number of people who have taken advantage of a strong Australian dollar and weaker international economic conditions, and purchased a holiday home in an overseas country in the last year.

Many older Australians are buying houses in the United States and Europe, with France and Italy among the most popular locations. They are finding homes at reasonable prices in countries with weaker economic conditions, including lower interest rates.

The strength of the Australian dollar also saw a large number of people buying luxury goods (like boats and cars) from overseas countries. The Australian dollar has been at 20-year-highs against most of the major currencies and was one of the best performing currencies of 2010.

Consumers tend to make these large foreign purchases via bank transfers, or with their credit cards or via Pay Pal. However, bank margins can vary, with exchange rate margins as high as 3 per cent in some instances.

Shopping around

If your clients are looking to purchase foreign goods or invest in excess of $1,000 internationally, it is well worth shopping around for lower fees and much more reasonable rates closer to those that are published.

Foreign exchange brokers can provide your private and corporate clients with more competitive foreign exchange rates, as well as advice on exchange rate movements and strategies to protect against adverse exchange rate fluctuations.

For clients who are buying property overseas and know their settlement date, a forward contract can be an attractive option, especially if their funds are tied up in a term deposit.

It enables clients to fix an exchange rate up to a year before payment is due and avoid currency fluctuations.

Individuals can fix an exchange rate for the property settlement date, hedging against any downside movements in the exchange rate.

To secure a forward contract, clients typically need a 5 per cent deposit — and the broker reserves the right to increase the deposit margin if the market moves.

Hedging the rate provides peace of mind in the most volatile and unpredictable financial market in the world. It’s just not worth the risk or the worry to leave things open to adverse rate movements when you are purchasing valuable goods, such as overseas property.

For clients whose transactions are more time critical, they are more likely to use a ‘spot rate’ (ie, the rate at the time of purchase).

If people have the funds available and are under less time constraints with their international purchases or investments, they can lock in an attractive spot rate for periods of up to 12 months.

While the Australian dollar remains high, there are an increasing number of people sending money back to overseas savings accounts as part of their savings strategy.

Some of these are taking advantage of spot rates, or they are locking in a rate on a forward contract for the next 12 months so they know exactly how much money will move across each month.

Target practice

Some clients with a greater capacity for risk might be interested in setting up a ‘target’ rate agreement, whereby they set the maximum and minimum amounts that can trigger an exchange. If the target rate is reached, even while the Australian market is closed, it will ‘trigger’ an exchange at that rate whether it is the maximum or minimum price.

Where you see the majority of big moves in currency exchange rates is on the US and European markets, which operate overnight when the Australian market is closed. They have bigger flows of money and there is more volatility in exchange rates off the back of the volumes exchanged.

Clients with foreign exchange purchases in excess of $100,000 can elect to hedge half of the amount and leave the other half to the spot rate on the day of exchange. The percentage that is hedged and not hedged can be customised to suit an individual’s risk profile.

While the Australian dollar has enjoyed record gains against most of the majors such as the pound and euro, it has been argued that it is overvalued and could correct itself during the course of 2011.

The Australian dollar has been particularly volatile against the euro and the US dollar in the last 12 months, with movements of up to 25 per cent. With signs of things picking up in the US and some of the European economies, combined with likely interest rate rises here, the value of the Australian dollar is likely go down.

The most important lesson to learn from the past 10 years is to get in while the going is good. The Australian dollar lost over 30 per cent of its value to reach a low of $US0.6001 following the collapse of Lehman Brothers in September 2008 at the onset of the global financial crisis (GFC).

In times of economic hardship such as the GFC, investors typically move funds to safe havens like gold and the US dollar. They simultaneously take money out of riskier assets, like commodities, which in turn weakens the Australian dollar.

There are a lot of factors that could have a negative impact on the Australian dollar in 2011. For example, the Queensland flood event drove the Australian dollar lower given it was occurring in one of the country’s major commodity-rich regions.

If the Chinese economy performs well, demand for commodities remains robust — which has positive implications for the Australian economy.

However, China is looking to increase interest rates and reduce lending to prevent their economy from overheating. This is expected to have a negative impact on Australia’s economy during 2011.

People are advised to not get too complacent with the Australian dollar and consider protecting themselves against future currency movements.

It provides peace of mind to not be exposed to adverse rate fluctuations if you are looking to make future foreign exchange purchases — particularly a holiday house in your favourite overseas destination.

Renee Doughty is the senior private client dealer at World First.