DateMarch 20, 2018
Investors are becoming increasingly aware of the diversification benefits associated with having some global exposure in their portfolio. However, with global exposure comes currency risk, and how this risk is managed can have a significant impact on investment performance.
The decision to hedge is not always clear-cut, and may depend on the investment period as well as where the currency is sitting relative to its long-term average. Assuming mean-reversion, the risk of leaving your investment unhedged is greater when the AUD moves significantly below its historical average. Given that 60% of the MSCI World Index comprises US shares, Australian investors tend to be most concerned with managing their AUD/USD exposure. As the chart below shows, the AUD/USD can move significantly above or below its long-term average over time.
Source: Lonsec, Bloomberg
Looking back five years, the AUD was at USD 1.02, or 27 cents above the long-term average. If you had decided to hedge at this point, an investment in global shares would have earned a return of 14.2% p.a. compared to a possible unhedged return of 17.7% p.a. (based on the MSCI World Ex-Australia Index). Compare this to the situation 15 years ago, when the AUD was at USD 0.61, or 15 cents below the long-term average. Over this period, hedged returns would have earned 10.9% p.a. versus unhedged returns of only 7.1% p.a. (see chart below).
MSCI World Ex-Australia Index annualised returns (hedged vs. unhedged)
Source: Lonsec, Bloomberg
The hedging decision can often be a vital one. As the chart below shows, if you had invested $100,000 in global shares 15 years ago, your hedged balance would be $478,000, but your unhedged balance would be $293,000 (a difference of $185,000).
$100,000 invested in the MSCI World Ex-Australia Index (hedged vs. unhedged)
Source: Lonsec, Bloomberg
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