When the Aussie dollar gets wobbly, investment analysts head to the drawing board to devise new investment strategies. Over the past week, the Aussie dollar has plunged against the Pound, the US dollar and the Euro. If it starts to slide against the major currencies, then you’d want to be in a place where you can profit from it. How can you do this? One way is to invest internationally on an unhedged basis.

Anyone with a super fund or a retail managed fund will cringe at the sound of the words ‘international investing’; that’s because it has been one of the most miserable performers over the last decade.

Take a look at the asset performance chart below, which is sourced from Chant West, and run your eye across the returns gleaned from international investing over the past ten years. On both a hedged (1.6%) and unhedged (-3.7%) basis, international investing has been a dog. You would have been better placed leaving your money in cash. And these returns are before you deduct fees and expenses.

On the contrary, if you’d kept your money at home, you’d be well in the money. Australian shares have returned on average 7.2% per annum over the past ten years, with Australian unlisted property returning an even grander 9.5%.

But now turn your eye to the most recent performance numbers; over the past year, international investing has been the top performer with international shares (22%), global listed property (33%), global listed infrastructure (17%), and international bonds (7%) beating most domestic equivalents. (Note that these figures are until June 2011, so they don’t factor in the plunge in July & August). For instance, Aussie shares returned 11.9%, Australian listed property, 10%, and Australian bonds, 5.5%.

Clearly, now, we’re talking about exciting returns that have come off a low base. The US and European markets were hit hard during the global financial crisis and much of these returns are simply a case of catch up. And yes, we’re only quoting international returns on a hedged basis here, which means that the funds have removed the impact of the currency on performance. If you had invested in an international shares fund that was unhedged you would have made a rather dismal 2.7% return.

But if the Australian dollar begins to sink lower then investors may be better off in unhedged international funds to make the big dollars as the currency depreciates.

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Think about it this way. Let’s say you invest today into an international fund priced in US dollars at the current exchange rate (and it’s bound to change as this goes to press) of 1.06 to the US dollar. If the Australian dollar falls to 95 cents (and although this is a 11 cent drop, it’s still way over its historic average), you’re up 10%. And this is purely on currency alone. If the fund makes money as well, you can add these returns onto your total profit.

The two big question marks over this strategy is of course the outlook for international equities and the future direction of the Aussie dollar. If the Aussie continues to remain high against the other major currencies, international investing on an unhedged basis will not deliver the rewards. In fact it will continue to be a lousy strategy, particularly if markets continue to tumble.

So what should you be looking out for? As an investor contemplating this strategy you need to keep a close eye on the outlook for interest rates – and the futures market is one such place. Just this week the futures market started pricing in its estimation of the end-of-year cash rate at between 4 and 4.25%, meaning it thinks interest rate cuts will occur towards the end of this year. Lower interest rates in Australia would put downward pressure on the currency.

What else should you be investigating? Watch for any downward revisions to commodities prices. The Australian dollar is a commodity currency and follows the direction of commodities prices closely. Any negative sentiment towards investing in China or Asia generally could also weaken the Aussie dollar, which is regarded as a proxy for Asian growth.

Remember when conducting your research that you can easily fall into the trap of confirmation bias, which basically means that you’re hunting down and finding information that confirms your original thoughts. For instance, if you are bearish on the Australian dollar it’s easy to read articles about slowing commodity prices and slowing Asian growth, and ignore views on the contrary. Look at the numbers and not the hype and be aware of confirmation bias when you’re researching.

It’s important to note that when investing internationally on an unhedged basis you have to get onto the strategy early to ride the momentum down. There’s no point waiting until the currency has already moved, because the gains will have been lost. The early bird gets the worm when it comes this strategy.

The downside is the extra amount of risk you’re taking on, as you expose yourself to both currency fluctuations and the vagaries of international markets, so this isn’t a strategy for the faint-hearted. As always, do your research, assess the level of risk you’re comfortable with and seek advice on whether the strategy suits your needs.

>>Back to the newsletter to view other articles – August 6th 2011

This article is of a general nature only and does not take into account your individual circumstances. For advice, TheBull recommends that you employ the services of a qualified financial adviser.