Few things are more important – and frustrating – for global share investors than currencies. Picking the Australian dollar’s trend against major currencies can make a huge difference.
I learned this the hard way. In the mid-90s, I was convinced global equities had better prospects than Australian shares (working for a US investment bank influenced my thinking). So, I invested heavily in international shares funds that had unhedged currency exposure.
The Australian dollar galloped to almost parity with the Greenback by 2008, wiping out a decade of gains in my international funds and then some. Ouch.
Too many investors forget that when investing overseas (in unhedged currency terms) they must form a view on the underlying security and their currency. Getting both views correct can supercharge investment returns for those prepared to take currency bets.
Still, there is a good argument that small investors should eliminate currency risks by choosing funds with hedged currency exposure. If you want exposure to US equities, why add a layer of dollar risk when currencies are notoriously hard to predict?
Many ASX-quoted Exchange Traded Funds (ETFs) eliminate currency risks. Some cost a little more but the currency hedging is worth it for those wanting to reduce risk.
Those prepared to embrace currency risk do so at an interesting point. The Australian dollar lost US2 cents this week – a two-year low – and currency forecasters are reducing their targets. Many expect the Australian dollar to trade below US70 cents this year.
This matches my view. I have noted several times for The Bull that the Australian dollar is in a multi-year downtrend.
I wrote in late 2017: “A gradual move to around US65 cents – an important point of technical support on the Australian dollar chart – is a good bet within two years. If that happens, investors in unhedged global equities will be boosted by a lower Australian dollar (assuming equity prices are constant).”
The Australian dollar has fallen from US75 cents in November 2017 to US72 cents. Better-than-expected economic growth figures this week provide some currency respite, but gains will be short-lived.
After a brief rally in late 2017, our currency has been in a pronounced downtrend and looks to have broken important price support in its chart, using technical analysis.
Australian dollar to US dollar chartSource: XE
Several factors are weighing on the Australian dollar. The official cash rate may be on hold longer than expected after Westpac Banking Corporation this month launched an out-of-cycle rate hike (a move the other major banks will surely follow). A widening yield differential between US rates (rising) and Australian rates (firmly on hold) pressures the currency.
Risk aversion is another factor. A rising US dollar is bad news for emerging countries with lots of US-dollar-denominated debt and because it encourages capital to flow to the US. The threat of trade wars and uncertainty with Donald Trump’s Presidency add to risk aversion.
Overseas investors view the Australian dollar as a proxy for exposure to emerging Asian markets because the region is a big buyer of Australian commodities. The upshot is that concerns about emerging markets weigh on the Australian dollar.
The good news is that global economic growth is okay and commodity prices – crucial to the Australian dollar – have reasonable support. Commodities are the main reason the Australian dollar will gradually ease to US65 cents and find a base. I do not subscribe to the bears’ view that our dollar will crash as global growth stalls.
That said, risks are to the downside. I have revised my forecast to US60-65 cents after events this month. The Australian economy has weaker than latest official figures imply in my view, meaning the Reserve Bank of Australia could keep the official cash rate on hold longer than expected – or even cut it in the next two years.
An Australian dollar at US60-65 cents would boost returns for investors who have unhedged currency exposure (from today’s currency, assuming constant equity returns). I cannot see the Australian dollar’s downtrend reversing anytime soon given the headwinds.
Those seeking pure currency exposure should consider currency ETFs – a strategy I have outlined previously for The Bull.
The ASX-quoted Betashares US dollar ETF has been my preferred option. The ETF provides low-cost exposure to the US dollar relative to the Australian dollar. If the US dollar rises by 10 per cent against our dollar, the ETF is designed to rise 10 per cent. The ETF’s management fee is 45 basis points annually.
The ETF has returned 9.4 per cent over six months.
Betashares US dollar ETFSource: The Bull
The ETF Securities Physical US dollar ETF is another option. It, too, provides exposure to a rising US dollar relative to the Australian dollar and charges 30 basis points.
• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at Sept 5, 2018.