Currency: walking the walk

If money really does have the power of speech in the way those with a penchant for clichés often purport it to, what would it say?

For the Australian dollar, perhaps in light of its year-long rise against the US dollar, we should expect some exclamation of dizziness or maybe euphoria. Meanwhile, the US dollar may alert those close enough to hear that it is feeling depressed or perhaps a little weak.

However, talk or no talk, it is important for investors in international equities to listen to what currency has to say.

“If you’re investing in international equities then you need to understand what you’re exposing yourself to. You’re effectively investing in two asset classes — you’re not just taking a position on equities, you’re guessing as to what the Australian dollar will do in the future,” Deutsche Asset Management (DeAM) senior portfolio manager Anthony Michael says.

Just over four years since the bursting of arguably the biggest stock price bubble in history, international investment markets are now emerging from the wilderness. However, for Australian investors the recent surge in the strength of the Australian dollar relative to its US cousin is seriously impacting on many investor returns and raising the issue of hedging.

“I don’t think the argument is necessarily about being hedged or unhedged, but more about when an investor jumps on board,” Credit Suisse Asset Management (CSAM) head of international equities Russell Bye says.

However, Bye argues that for many the benefits of whether to hedge or not have already been lost. “Traditionally, people give up on currency when it’s fallen a lot, while many people start to fully hedge once a currency has already significantly risen, which is arguably the worst time to hedge,” he says.

Meanwhile, Colonial First State head of fixed interest and foreign exchange Warren Bird believes for retail investors the issue is more about long-term investment.

“We don’t believe anyone has any idea which way the currency will go in the future and as such we don’t actively manage it based on predictions of which direction it will go.

“We believe investors should invest in international equities for the long run anyway, and that short-term currency fluctuations shouldn’t really play a big part in their decision to invest or not,” Bird says.

Furthermore, Sovereign Investment Research principal Ray King believes exposure to the currency markets provides an additional dimension of diversification to a portfolio.

“A little bit of currency exposure is beneficial from a risk management perspective. It’s not a question of being covered around the time an investor plans to redeem an asset, it’s more about having diversity,” King says.

On the issue of the Australian dollar’s appreciation, Macquarie Bank estimates 80 per cent of the rally against the US dollar reflects the latter’s weakness, with the remaining 20 per cent the result of robust local factors (most notably relatively high interest rates) and improving global economic conditions.

According to Macquarie associate director Jo Masters, the US dollar will remain a key factor in the outlook for the Australian dollar.

“Currency markets are in that uncomfortable position where it is unclear whether this is the turning point for the US dollar or just a short-term correction in extremely positioned markets,” Masters says.

She adds turning points are usually only identifiable in retrospect and often marked by periods of volatility and choppiness, which can extend from a few days to several months.

Irrespective of the debate as to whether this turning point has been passed, DeAM’s Michael argues the first thing a retail investor needs to know upon making an allocation to overseas shares is what their currency exposure will be.

“Investors need to know what a fund manager’s position on currency is — as in whether the manager in question is completely hedged, unhedged or partially hedged, along with whether it manages currency passively or actively.

“It’s all good, for instance, to say the Aussie dollar has peaked against the US dollar, the Euro or the Yen. But there’s no point investing with a manager if it’s unclear what their stance is on currency,” Michael says.

Without this information, Michael believes the investor will run the risk of investing across two asset classes — international equities and active currency management.

Back to the debate about where the US dollar is heading — Macquarie’s assessment is that it is in the process of bottoming out, with positive momentum likely to be triggered once currency markets become confident the US Federal Reserve is on the cusp of raising interest rates, although this may not occur for some time.