For financial advisers and professional investors only – not for distribution to retail investors.
November 8, 2024
Hedging is a tool that can be used to manage currency exposures across global equity portfolios. While it seeks to remove the impact of currency movements, there are important pros and cons for investors to consider.
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1. Hedging is a tool that can be used to manage currency exposures across global equity portfolios.
2. While differences in unhedged and hedged performance can ‘wash out’ over the long run, short-term performance can differ significantly. Strength in the AUD favours hedged performance while weakness in the AUD favours unhedged performance.
3. Unhedged exposures to global equities have had the advantage of being more defensive during major share market selloffs, as historically the AUD has fallen during those periods.
4. On the other hand, hedged exposures can make sense when you take the view that the AUD is likely to rise in the future. Adjusting the mix of unhedged versus hedged exposures is one way to express currency views in a portfolio.
When you invest in global equities, you are exposed to two different prices: the price of the stock itself, and the price of the currency it trades in. If, for example, your shares are listed on the NASDAQ in US dollars (USD), and the value of the USD rises against the Australian dollar (AUD), your returns will be higher when you convert them back to AUD.
Effectively, you receive an equity market return plus a currency market return. However, in the example above, if the AUD strengthens against the USD, your global investment returns would be lower.
Some investors choose to hedge against currency movements by investing in a hedged fund, to take currency movements out of the equation and link their investment exposure more closely to the performance of the underlying stocks.
Currency movements are hard to predict so you might think it is best to hedge them, but you really need to look at an entire portfolio, and the impact of hedging on your risk and return outlook from an AUD perspective”
Luis Sarmiento
Senior Investment Specialist
Macquarie Professional Series
It’s not always an easy decision to make, but it is an important one. Here are some considerations for investors.
Hedging performance can vary
Over the long-term, as shown in Figure 1, historical data shows marginally higher returns for the hedged version of the MSCI World ex Australia global equities benchmark compared to unhedged (9.3% pa versus 8.9% pa), at the cost of higher volatility (14.5% pa versus 11.6% pa).
Figure 1: Historical long term returns of unhedged and hedged global equities
Source: Morningstar, Bloomberg, MSCI, for the period from 31 March 2005 to 30 September 2024. Shaded areas refer to all drawdowns for the MSCI World ex Australia Hedged Index greater than 15% since March 2005.
Over shorter timeframes, however, unhedged returns have often exceeded hedged returns by a significant amount, and vice versa. For example, over the three years to 30 June 2024, the unhedged MSCI World ex Australia Index returned 11.2% pa, compared to hedged returns of 7.0% pa.
So why can hedged and unhedged performance vary over the short term? There are many factors at play, including of course the performance of the Australian dollar against major currencies, but also interest rates around the world, and the interactions between currency and equity markets.
Why choose an unhedged global equity exposure?
With global equities now seen as a core portfolio allocation for Australian investors, thanks to their return potential and diversification benefits, more investors will need to consider whether, and when, to hedge.
Australian portfolios were traditionally weighted towards homegrown shares on the ASX. However, as shown in Figure 2, the average Australian super fund now has an even larger allocation to international shares. Interestingly, almost three-quarters of this international exposure is not hedged against currency movements.
Figure 2: Average Australian superannuation allocations
Source: APRA, Quarterly Superannuation Statistics, September 2023.
One reason for this is that during major share market selloffs, investors tend to seek shelter in ‘safe haven’ assets, such as the USD, rather than those they perceive as higher risk commodity currencies like the AUD. As a result, the AUD is more likely to depreciate – and this can act as a buffer against global market weakness.
Unhedged global exposures benefit from a falling AUD. We saw this during the global financial crisis, when the AUD/USD fell by around -31%. The unhedged MSCI World ex Australia Index returned -33%, and the MSCI World ex Australia Hedged Index returned a significantly more extreme -51%1
As shown in Figure 3, we see a similar cushioning effect from AUD depreciation in all market drawdowns over the last 20 years in which the MSCI World ex Australia Hedged Index fell by more than 15%.
Figure 3: Unhedged and hedged global equities through market drawdowns
Source: Morningstar, Bloomberg, MSCI, for the period from 31 March 2005 to 30 September 2024. Drawdown periods calculated using monthly return data.
The Australian dollar tends to synchronise with global markets due to our economy’s reliance on pro-cyclical export-led growth. So, if the global stock market is down, the AUD also tends to fall, which helps protect the value of your investments offshore,”
Luis Sarmiento
Senior Investment Specialist
Macquarie Professional Series
That’s why, although currency hedging aims to reduce currency risk from portfolio returns, it can inadvertently result in higher overall volatility of returns over the long run.
Why choose a hedged global equity exposure?
Since the Australian dollar was first floated in December 1983, its price relative to the USD (and other currencies) has been set by buyers and sellers in the market.
Over the decades since, as shown in Figure 4, the AUD has traded as low as 0.479 USD (on 2 April 2001), and as high as 1.102 USD (on 27 July 2011). As at the end of June 2024, for each Australian dollar you could get 66.7 US cents. The Australian dollar has historically traded below this exchange rate less than 25% of the time.
Figure 4: USD/AUD since 1983
Source: Bloomberg, for the period from 12 December 1983 to 30 September 2024.
If you take the view that the Australian dollar is currently ‘cheap’, and likely to rise, it may make sense for you to hedge some or all your global equity exposures. As mentioned previously, a rising Australian dollar hurts the value of offshore assets and currency hedging can protect you from the effects of currency movements.
Conversely if you believe that the Australian dollar is currently ‘expensive’ relative to other currencies, and particularly the USD given the large weight of US shares in the global equity index, choosing unhedged global equity exposures would position your portfolio to benefit from a falling AUD.
In this way, choosing between hedged or unhedged global equity exposures is one way to implement a currency view within your portfolio.
What is the optimal level of currency hedging?
There is no right or wrong level – it’s a matter of balance at any point in time.
As the table below shows, there are considerations for a portfolio’s broader currency exposures and the risk-return profile, as well as the market outlook and your time horizon. Ultimately, your hedging level is not just about seeking additional returns, it is also an important tool to help manage risk.
| Considerations for global equity portfolios | Unhedged | Hedged | |
| Currency exposure | Exposed to swings in currency movements. AUD rising hurts investment returns, AUD falling helps investment returns. | Aims to reduce exposure to currency movements from investment returns. | |
| Equity market corrections | Has historically outperformed given the AUD tends to fall when global equity markets fall. | Has historically underperformed given AUD tended to fall when global equity markets fall. | |
| Implementing a currency view | For investors who view the AUD as expensive and more likely to fall than to rise. | For investors who view the AUD as cheap and more likely to rise than to fall. |
Learn more about our hedged and unhedged global equity funds
Macquarie Professional Series offers hedged and unhedged versions of its global equities managed funds listed below, with currency exposures managed by an in-house team of currency specialists with over 20 years of experience.
“Our currency team takes a passive approach to hedging, using currency forwards to lock in future exchange rates on a rolling basis”, explains Sarmiento. “The aim is to deliver the same benchmark outperformance as the unhedged option, but against the hedged benchmark.”
Investors can switch between the hedged and unhedged versions of the funds to manage their currency exposures over time. Switching may incur costs (e.g. buy/sell spreads) and may have tax implications which should be considered.
Discover our global equity managers, proudly brought to you by Macquarie Professional Series:
The Funds listed are designed for consumers who:
- are seeking capital growth and income distribution
- are intending to use the Fund as a core component, minor allocation or satellite allocation within a portfolio
- have a minimum investment timeframe of seven years
- have a high or very high risk/return profile for that portion of their investment portfolio, and
- require the ability to have access to capital within one week of request.
The Target Market Determination (TMD), available at macquarie.com/TMD, includes a description of the class of consumers for whom the Fund is likely to be consistent with their objectives, financial situation and needs.
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The Fund(s) mentioned above may have multiple classes of units on issue. A separate class of units is not a separate managed investment scheme.
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