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Shifting Gears: The Australian Dollar’s Roller Coaster Ride
- Timing markets and especially currency markets can be challenging
- We review the impact of currency to investor returns for 2020
- And explain why hedged and unhedged exposures differently impacted investors’ portfolios for the first half of 2020
The first half of 2020 proved to be a roller coaster ride for investors. Equity markets sold off through the first quarter as market risks spiked with the spread of COVID 19 but rebounded in the second quarter as central banks came in to support the global economy.
That roller coaster ride was also seen in the Australian Dollar (AUD). After hitting a record low in March 2020 against the United States Dollar (USD), the AUD has since rallied, reaching a 12 month high and exceeding levels prior to the COVID-19 selloff.
Source: Bloomberg Finance L.P., 31 August 2020
The rebound of the AUD has been driven by a number of factors:
- Risk rally. With the AUD being a high beta currency, seeing it selloff in high risk environments and rally as the perceived risk environment improves is not unusual.
- Falling USD has seen relative strengthening in the AUD. Over the last few years, interest rates in the US have been higher than in Australia. However, the effective Federal Funds Rate in the US was slashed close to zero while the Reserve Bank of Australia provided some optimism by dismissing the possibility of negative interest rates.
- Increased optimism around COVID-19 and the economic data. An economic rebound in China, Australia’s biggest export market, and positive developments on a coronavirus vaccine have also helped the AUD rally against USD. We have also seen better containment of the virus domestically, despite the recent surge in infections in Victoria.
Going forward we expect to see further choppy waters for the AUD, this outlook is impacted by a number of factors. Longer term, valuations metrics will drive the AUD but with the difference between interest rates between Australia and the US now at zero, short term factors may find more prominence.
Source: Bloomberg Finance L.P., 31 August 2020
Market risk will be a significant driver of shorter term currency moves, and with the AUD being a high beta currency it will be more exposed to short term risk factors. For Australian’s investing in international markets, currency is likely to have a significant impact on the returns they generate.
Year to date we can see the impact.
Source: Bloomberg Finance L.P., 31 August 2020
Hedged investors faced larger drawdowns through the market selloff. Unhedged investors who maintained some foreign currency exposure experienced reduced drawdowns through the selloff as the foreign currency provided some diversification benefits. Conversely the unhedged investors lagged in the market rally as the AUD benefited from the improving risk sentiment.
While timing markets is notoriously difficult, it’s important to understand the impact that currency can have. Longer term strategic views should form the baseline for determining what currency exposure to hold but adjusting that exposure based on understanding the risk related characteristics of currencies can help investors navigate through shorter periods of market risk.
Whatever your view around the correct hedge ratio to target, the ability to blend hedged and unhedged ETFs makes implementing those views easy to achieve.
The views expressed in this material are the views of Rafiq Choudhury through the period ended 31 August 2020 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Investing involves risk including the risk of loss of principal. Past performance is no guarantee of future results.
Risk associated with equity investing include stock values which may fluctuate in response to the activities of individual companies and general market and economic conditions.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
Companies with large market capitalizations go in and out of favor based on market and economic conditions. Larger companies tend to be less volatile than companies with smaller market capitalizations. In exchange for this potentially lower risk, the value of the security may not rise as much as companies with smaller market capitalizations.
Currency Risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged. Currency Hedging involves taking offsetting positions to reduce exposure to different currencies. These currency exchange contracts may reduce or eliminate some or all of the benefit that an investment may experience from favorable currency fluctuations.
Adtrax: 3233488.1.1.ANZ.INST
Expiration: 30/09/2021