International investing, currency and your super
The Australian investment market tends to be heavily dominated by banks and resource companies, which means investment opportunities are broadened by investing in markets outside Australia. For example, strong growth opportunities may be offered by technology and pharmaceutical companies, which are a much bigger part of overseas markets.
When investing internationally, changes in the exchange rates between currencies contribute their own risk of high volatility and investment losses. Currency exchange rates are a relatively independent factor that affects the value an investor actually sees at the end of the day. This is known as currency risk (also as foreign exchange risk or exchange rate risk).
As an AvSuper member, it is the return in Australian dollars (AUD) that ultimately matters to you and your super balance. Returns and valuations on international investments are determined only when the foreign currency is exchanged back into AUD.
How currency conversion affects investments
Consider, as a simple example, achieving an excellent 10% return on an Australian investment in US dollars (USD).
Initial international investment and outcome
|AUD||Exchange Rate||USD||Investment Return||USD|
Final currency conversion
As illustrated in the table below, if the AUD appreciates by 10% relative to the USD over the period of the investment, the subsequent conversion of the USD proceeds to AUD would result in a 10% translation loss, and eliminate the entire local investment return. On the other hand, if the AUD had depreciated by 10% over that period, an additional 10% would be added to the return.
|Currency change||USD||Exchange Rate||AUD||Ultimate
|AUD appreciates 10%||$7,700||0.77||$10,000||0%|
|AUD depreciates 10%||$7,700||0.63||$12,222||22%|
Exchange rate movements have the potential to cause large capital losses. The following chart shows over a decade of changes to the Australian dollar to US dollar exchange rate to help demonstrate the potential for exchange rate changes to impact the value of international investments.
Figure 1 – AUD/USD exchange rate over time
AvSuper invests across a number of international markets in a number of currencies, including US Dollars, British Pounds, Euros and Swiss Francs. This adds complexity to the important task of managing the mix of currency risks.
One of the key objectives of managing currency risks is consistency of returns. Consistency is central to the investment strategy we implement for our members because it lends a degree of flexibility to retirement plans.
How does AvSuper manage currency risk for you?
There are two key components to the currency risk management approach taken by AvSuper.
Setting a hedging level
AvSuper appoints advisors to work with the Investment Committee to form a general view on where the Australian dollar exchange rate might move in the medium term and to set an appropriate hedging level in response. These decisions are made by reviewing various factors that impact on exchange rates. When the dollar is expected to appreciate (which would cause losses on overseas investments) a high level of hedging is called for. This is known as a “high strategic benchmark hedge”. Extreme conditions may call for a 100% strategic benchmark hedge, according to which a currency manager would enter into currency forward contracts that lock in the Australian dollar return at today’s rates. Hedging in this way would protect against the impact of future Australian dollar appreciation.
Due to the many and varied factors affecting exchange rates it is difficult to choose a strategic hedge benchmark with a high level of confidence. As the potential direction of the Australian dollar exchange rate movement is often unclear, AvSuper generally doesn’t adopt fully hedged (i.e. a 100% strategic benchmark hedge) or fully unhedged (i.e. a 0% strategic benchmark hedge) positions. Since our aim is to reduce volatility and achieve more consistent returns, a 50% strategic benchmark hedge can be sensible. This position would mean our international investments would avoid half the losses associated with any AUD exchange rate appreciation, and still stand to make half the gains of any AUD depreciation.
Having set the strategic benchmark hedge with a medium term focus, AvSuper then relies on the expertise of specialist currency managers to manage the risk further.
The currency manager has the objective of delivering an outcome that is better than that of the strategic benchmark hedge. Using sophisticated currency models that take into account many short and long term factors affecting exchange rates, they will adopt hedging levels above or below the strategic hedge benchmark according to their prevailing view. A key part of their currency strategy is to ensure that the currency result for our investors is no worse than 3% less than what would have been delivered by simply implementing the strategic hedge benchmark provided to them by our Investment Committee.
The combination of these two layers of currency risk management is aimed at achieving a “smoother” investment path for our members. This objective is illustrated in Figure 2 below.
Figure 2 – Smoothing the investment path
Email: firstname.lastname@example.org | Freecall: 1800 805 088 | Phone: 02 6268 5073 | www.avsuper.com.au
This information is of a general nature only and does not take into account your personal objectives, situation or needs. Before making a decision about AvSuper, you should consider your own requirements and the relevant Product Disclosure Statement (PDS). For a copy call us or visit the AvSuper website, www.avsuper.com.au. AvSuper Pty Ltd (ABN 46 050 431 797, AFSL 239078) is the Trustee of the AvSuper Fund (ABN 84 421 446 069). FS5025.1 03.2016