(03) 9020 2905At a given point of any cycle, there’s bound to be a few markets with their heads in the stratosphere.
Gold, for one, has never been this high. Chinese demand for raw materials means there might not be much left of WA inside a decade. The comeback market for 80s Australian rock stars is stubbornly high. We’ll know that’s peaked and has nowhere left to go if Collette re-releases “Ring My Bell”.
And the Australian dollar … high as a kite. The world is desperate for a piece of the action here, whether that’s our dirt or our relatively high interest rates.
But it has been a true roller coaster ride. Over a two-year period to mid-2008, Australia’s dollar rose from around US72c to US97c. Over the next five months, it slumped briefly to US60c. It’s only taken about six months to recover most of that, and is now back around US92c.
In less than four years, it rose 34 per cent, then fell 38 per cent, then rose 53 per cent. The average over that time? Around 77c to 78c. (In the five years before that, however, the average would have been below US70c, as the Aussie crashed, at one stage, to around US47c.)
A high currency can be both good and bad for an economy, as it creates imbalances. The usual areas highlighted are that it’s harder for Australian exporters, but imports become cheaper. And while our tourism suffers, Australians can more easily travel abroad.
If our currency were closer to its average of US70c, the cost of petrol would be closer to $1.50 a litre.
So, how can investors profit from the dollar’s strength? There is plenty of stockbroking research that discusses those companies that will benefit as our currency increases (import-focussed firms) and those that will benefit as it deflates (those with an export focus).
But currencies are about as close to a long-term, zero-sum game as occurs in the investment world.
That’s zero sum in terms of there being a roughly equal number of winners and losers. Not zero sum like how much a million shares in Christopher Skase’s Qintex is still worth in 2009, two decades after it collapsed.
The real potential opportunity now, when the dollar is arguably high, comes from Australians being able to buy foreign assets and benefit as our currency falls in value.
Let’s take an asset in the US going for $US100,000. If the exchange rate was US70c, it would cost us nearly $A142,900. However, at US92c, we would get change out of $A108,700.
It’s the same asset. But the cost to us, as Australians, is 23.9 per cent cheaper.
Currency added to normal investments creates extra risk. If the dollar increases from US92c to US$1.10, the asset when converted back to Australian dollars is now only worth $A90,900.
The opportunity comes from the possibility of “reversion to mean” – a belief that the Australian dollar will retreat towards its long-term average of US70c.
Retail investors can potentially take advantage of this opportunity through “hedged” and “unhedged” international managed funds.
Hedged means that currency fluctuations have been removed as an influence, while unhedged means the investment will be impacted by exchange rates.
During the crash in the currency from US97c to US60c, those who were in unhedged funds massively outperformed hedged offerings.
If we assume that our investor bought in at US90c and sold out at US65c (they did not pick the top or the bottom of the market), then they would have added an enormous boost to their portfolio. I’ll use Vanguard index funds to illustrate.
Between February 2008 and February 2009 (when the dollar traded at US90c and US65c), Vanguard’s International Shares Index Fund (Hedged) fell in value by nearly 51 per cent. However, if you were unhedged over the same period, your investment would have only slipped by about 24 per cent.
Nearly 27 per cent in outperformance was gained by taking an extra risk on hedged products.
Sure, it was still a loss. But it was less of a loss. And losing less money is clearly better (Would you rather lose a bet for $100? Or the same bet for $200?), despite what some commentators say.
Bruce Brammall is the author of Debt Man Walking (www.debtman.com.au) and a licensed financial adviser. bruce@debtman.com.au .