In recent weeks we have seen the Australian manufacturing sector blame the high Australian dollar on poor business results in the last couple of years. It is a timely reminder that currency fluctuations can have an impact on our investment portfolios, be it inside our superannuation or outside of superannuation.

hedge_01

 

Source: RBAhedge_02

How do the fluctuations in the Australian dollar (AUD) affect my investment portfolio?

When investors buy an asset denominated in a foreign currency, their return is determined by the return of the foreign asset and the return of the currency.  The impact of exchange rate movements on the investor’s return can be reduced by hedging the currency exposure of the foreign asset.

What is hedging?

Hedging refers to the ability to mitigate currency risk by taking short term positions on AUD in the form of forward contracts and options contracts, to neutralise the effects of currency on the performance of overseas assets.

Most balanced portfolios will have exposure to international shares and bonds. Therefore there is a high likelihood that currency fluctuations do affect you.

When you have investments in international assets which are unhedged, a rise in the Australian dollar relative to other currencies will negatively impact investment values and returns.

Conversely, when you have investments in international assets which are unhedged, a fall in the Australian dollar will have a positive impact on values and returns. Hence, with the recent fall in the Australian dollar (AUD) January 2013 to January 2014, unhedged international funds have outperformed their hedged counterparts.

Over the long term it has been proven that the difference between unhedged and hedged exposure is negligible after costs. However when you are retiring or in pension phase you may wish to reduce currency risk by hedging your international exposure.

Hedging your international exposure is an important decision in any portfolio. What is your position…

Disclaimer- Past performance is no guarantee of future results. This information is provided in a general nature and does not take into account your personal circumstances or objectives. Thus should not be considered investment advice.