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Matthew Smith has been a business and financial journalist for more than a decade. He previously worked with the Financial Times Group, reporting from New York on company buyouts and refinancing in the wake of the Global Financial Crisis. He started his career reporting on the funds management industry in Sydney.

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Pundits hedge bets on international shares as $A stays strong

Published 29 April 2013 12:37, Updated 29 April 2013 12:46

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Pundits hedge bets on international shares as $A stays strong

Whether Australian investors with investments in overseas shares should remain unhedged is still unclear.

To hedge or not to hedge, that is the question. If anything, the gravity defying efforts of the Australian dollar since 2011 have taught many of us – experts included – to not get too far ahead of ourselves when it comes to making predictions on the value of the currency.

The house view at most banks and financial institutions is that the $A is overvalued, a position most institutions have maintained for going on a year and a half now since the currency has been trading around record levels against the US dollar.

For investors with allocations to overseas equities, subscribing to this view would have meant maintaining an unhedged position during this time.

By not hedging, returns on investments in non-Australian markets are enhanced as the $A declines in value; that of course assumes the value of the domestic currency is declining faster than the currency of the market the investment is in.

However, remaining unhedged in overseas markets would have, at times, eaten into potential gains made by international share investments since the start of 2011.

For instance, an investor who bought shares in a US company at the start of July last year when the $A was trading at US97¢ would be facing a US7¢ headwind if they wanted to sell their investment at the $US1.04 level the currency was trading when this story went to press.

That means a valuable share price gain of US7¢ in a share investment in a US company would have been reduced to zero if that investment was left unhedged, as would have been deemed sensible by most currency strategists during this period. Indeed, most investors are choosing to remain unhedged in the current market, says Jim Vrondas, OzForex chief currency and payment strategist for Asia Pacific.

While Vrondas doesn’t weigh into whether the $A is trading at true value, he says what’s important for investors to consider in the context of hedging their overseas investments is timing their exit strategy.

What do you do if the $A falls from $US1.05 to US95¢? That could be a decision point.

“What do you do if the $A falls from $US1.05 to US95¢? That could be a decision point. Do you sell and take the return and invest somewhere else? Do you lock in a hedge? Or do you remain unhedged with the view the dollar will continue to fall?” he says.

More people today are investing in international markets through direct shares and exchange traded funds outside of managed funds structures that have traditionally handled currency hedging risk, says Riccardo Briganti, head of research at Macquarie Private Wealth.

Briganti also notes the trend for investors to remain unhedged in international share investments with the Aussie trading at current levels.

When it does comes time to put a hedge in place, there are a number of options available to investors looking to do it themselves.

According to Vrondas, the most common method used by investors who trade in individual stocks to hedge currency risk is forward contracts and options contracts, where an investor can lock in a price at a predetermined date in the future. He also notes that demand for forward contract deals have roughly mirrored price movements in the Australian dollar among his clients (see graph on p46).

Other ways to build a hedge

Besides forward and options contracts, investors in overseas sharemarkets have a number of hedging options, including contracts for difference (CFD), investing in hedged mutual funds or exchange-traded fund (ETF), investing directly in or shorting a currency to offset a share investment or looking for natural hedges across a share portfolio.

Michael Hamm, who trades his own share portfolio and blogs his experiences on his website 5000trades.com, says he uses one of a number of these hedging strategies at any given time.

CFDs are a leveraged product which allow him to borrow up to 200 times the funds in his trading account to cover an investment in overseas markets.

Vrondas notes that CFDs, like any leveraged investment, should be used cautiously, and can be a double-edged sword if the currency swings in the opposite direction.

Hedging by investing directly in a currency could be as simple as buying the same amount of Australian dollars as an investment in a US stock to offset risk in currency movements.

Buying a currency ETF can provide a return that more closely resembles equity movements rather than currency movements and, therefore, could be preferable to equity investors, Hamm says.

In terms of natural hedges, Hamm says that he is always looking for opportunities within his portfolio where one investment or position in an overseas market can be offset by another.

Timing matters

Hamm says he is constantly questioning whether it is time to hedge a position. “Every quarter or every week I can change my view on currency – I could wake up tomorrow and start a currency hedge on one position or another,” he says.

Whether Australian investors with investments in overseas shares should remain unhedged is still unclear.

“Certainly the consensus view is the Aussie is high therefore don’t hedge – that’s what most advisers are telling investors,” says 8IP chief investment officer, Kerry Series.

Series’ personal view is the $A will push through the $US1.10 mark this year and he remains hedged on his personal overseas share holdings.

Investors with a longer term (three-year) time frame are likely to find less resistance to taking an unhedged position in global shares with the Aussie widely expected to drift lower over that time period.

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