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An allocation to international markets is an important portfolio diversifier for self-managed superannuation funds (SMSFs). If recent trends are anything to go by, it seems SMSF trustees need no persuading.
Australian Taxation Office (ATO) data shows SMSF trustees are increasing their allocations to global equities with $11.55 billion of SMSF assets invested in overseas shares in the June quarter 2021. That’s a near threefold increase on the $3.87 billion invested in overseas shares just five years ago.
But SMSF trustees also need to understand the impact that currency can have on returns for investments that are not denominated in Australian dollars.
Currency fluctuations can have both negative and positive impacts on portfolio returns. But investors who would like to remove currency risk from the investment equation can do so by hedging their currency exposure using a range of strategies.
What impact do currency movements have on returns?
A simple example can help illustrate the impact of currency on investment returns. Say you purchase shares in US-listed Company B for a total of US$100 when the exchange rate is US75c. In Australian dollars, the purchase will cost you A$133.
As you can see from Scenario 1 in the table below, an appreciating Australian dollar – for example, when the amount one Aussie dollar buys increases from US75c to US80c – will have an adverse impact on a US dollar investment when it is converted to Australian dollars. In this case, your original $133 investment is now valued at $125.
If the currency depreciates, it will have the reverse effect. In Scenario 2, the exchange rate falls from US80c in the dollar to US70c, and your investment increases in value to $143.
Scenarios 3, 4 and 5 show the different outcomes of exchange rate fluctuations on the value of a US-based company when its shares increase in value by $10. In Australian dollar terms, there is a difference of nearly $20 depending on which direction the currency moves.
| Company B USD | AUD/USD exchange rate (US dollars) | Company B AUD | |
|---|---|---|---|
| $100 | 0.75 | $133 | |
| Scenario 1: Company B maintains value but currency appreciates | $100 | 0.80 | $125 |
| Scenario 2: Company B maintains value and currency depreciates | $100 | 0.70 | $143 |
| Scenario 3: Company B increases in value and currency stays the same | $100 | 0.75 | $147 |
| Scenario 4: Company B increases in value and currency appreciates | $100 | 0.70 | $138 |
| Scenario 5: Company B increases in value but currency depreciates | $110 | 0.70 | $157 |
The asset sector performance table from Chant West (below) highlights the differences in outcomes for a portfolio of international shares depending on whether or not they were hedged.
International Shares Performance (Results to 30 June 2021)
| 1 yr (%) | 3 yrs (% pa) | 5 yrs (% pa) | 7 yrs (% pa) | 10 yrs (% pa) | 15 yrs (%pa) | |
|---|---|---|---|---|---|---|
| International Shares (Hedged) | 37.1 | 14.8 | 14.8 | 11.2 | 11.8 | 7.9 |
| International Shares (Unhedged) | 27.5 | 14.5 | 14.7 | 14 | 14.8 | 7.7 |
Source: Chant West
Over the 12 months to 30 June 2021, the Australian dollar appreciated from approximately US69c to US75c. So any investor in US shares who hedged their investment was able to insulate their portfolio from the impacts of that appreciation. Holders of hedged international share portfolios saw a 37.1% return for that 12-month period, compared to a 27.5% return for the unhedged portfolio.
However, the swings and roundabouts of currency fluctuations tend to even out in the long run.
As the long-term returns above show, the longer you stay invested the less impact hedging has on investment outcomes, with just 0.2 percentage points difference in returns over the 15-year time frame.
Gaining exposure to international assets
The vast range of international exchange traded funds now available to Australian investors, and listed on local exchanges, makes it much easier and cheaper to gain exposure to global equities than it was in the past.
SMSF trustees no longer need to rely on expensive managed funds on a platform for international exposure and can choose from hundreds of ETFs which offer a variety of access to different global sectors, countries and themes. Below is a table of seven broad global ETFs available on the Australian Securities Exchange (ASX). Only one of the below has a hedged option – the iShares Global 100 AUD Hedged ETF – and it’s also the most expensive. But many of the sector and themed international ETFs available on the ASX also offer currency hedged options.
| ETF | ASX code | Benchmark | Management cost % |
|---|---|---|---|
| Vanguard All-World ex-US Shares Index ETF | VEU | FTSE All-World Ex-US Index | 0.08 |
| iShares Core MSCI World Ex-Australia ESG Leaders ETF | IWLD | MSCI World Ex-Australia Custom ESG Leaders Index | 0.10 |
| Vanguard MSCI Index International Shares ETF | VGS | MSCI World Ex-Australia AUD Index | 0.18 |
| SPDR S&P World Ex-Australian Fund | WXOZ | S&P Developed Ex-Australia LargeMidCap AUD Index | 0.30 |
| iShares MSCI EAFE ETF | IVE | MSCI EAFE Index | 0.31 |
| iShares S&P Global 100 ETF | IOO | S&P Global 100 Index | 0.40 |
| iShares Hedged ETF | IHOO | S&P Global 100 Hedged AUD Index | 0.43 |
To hedge or not to hedge?
Choosing whether to hedge an international exposure means you need to take a view on the currency as well as on the investments in your portfolio. This adds an extra layer of complexity to any investment decision.
Generally, currencies are linked to interest rate movements. If a country’s central bank raises rates, its currency is likely to appreciate, as global investors follow the higher yield. If it lowers its rates, the reverse occurs.
But there are many other factors driving currency movements around the world, including general economic sentiment. For example, although interest rates everywhere remained suppressed during the 2020–21 financial year, the Australian dollar appreciated, on the back of a potentially improved economic outlook. But if the US was to start raising rates, as much of Australia remains in lockdown, the Australian dollar might then start to depreciate.
If we look to the professional investors as a guide, Australia’s large super funds, on average, do not hedge their international equity exposure.
According to the June 2021 Australian Prudential Regulation Authority (APRA) quarterly statistical data (for super funds of more than four members), of the $602.14 billion invested in international equities, just $152.05 billion, or 25% was hedged. That was down slightly on the 28% of international equity investments that were hedged in June 2020. It’s difficult to say whether that reflects the long-term nature of super, the outlook for the Australian dollar, or a bit of both.
As an SMSF trustee, you need to include any decisions you make about currency in your fund’s investment strategy. You should also consider including an explanation of why, or why not, you decided to hedge any international exposure.
Bottom line
When it comes to global investments, it’s important to consider the impact currency fluctuations may have on your returns. If you would prefer to eliminate currency risk as a factor in your returns, then a hedged investment product might be appropriate.
Some investors take a bet each way, by splitting their international allocations between hedged and unhedged versions of investment options. This helps protect a portfolio from the potential detrimental effect of an adverse movement in foreign exchange rates, while also enabling their SMSF to benefit if the currency moves in a favourable direction.
