Conversely if capital security is your over-riding objective then you will need to be content with lower levels of return over the long-term and even potentially an erosion of buying power thanks to inflation. The same is true of our currency. When it is low against benchmark currencies like the US dollar we may bemoan the pain that comes with travelling overseas but in a broader economic sense our exporters like it because they are much more price competitive in overseas markets. For investors the value of our currency is both a source of risk and reward. As a small part of the developed global economy there is a compelling argument for Australian investors to invest overseas for diversification reasons. Most major superannuation funds' default option will have between 20 per cent and 30 per cent invested in international shares and as our pool of superannuation savings continues to grow that is likely to rise further. That is a strong point of difference between the mainstream institutional super funds and those managed by individuals with their self-managed super fund who typically have much lower allocations to international shares. Certainly in the past 12 months overseas sharemarkets have delivered strong returns but the volatility of the Australian dollar has provided a timely reminder for investors why it is sensible to factor in a separate decision about whether to invest on a hedged or unhedged basis. For the financial year just ended that decision had an impact of around 8 per cent in total return terms. If we use the MSCI global sharemarket index (ex-Australia) as the benchmark then Australian investors who decided to hedge the currency risk enjoyed a return of 24.5 per cent. It is doubtful that anyone was unhappy with that outcome. But courtesy of the Australian dollar's fall from grace an investor in the unhedged version of the same index saw a return of 33.1 per cent for the 12 months ended June 30. The reasonably rapid fall in the dollar's value boosted the investment returns accordingly. It is anyone's guess whether the dollar will fall further, stay around current levels or rally again. Warnings about past performance being no guide to the future cannot be written in large enough letters when it comes to forecasting currency movements. If you look out over the past 10 years using the same two indexes then those investors who hedged the currency risk were ahead. Time frame is an important factor with any investment decision and currency is no different - the longer the time frame the more the range of returns tends to compress. But of course the journey can be as important as the destination when it comes to investor behaviour and if the currency volatility is extreme and it results in investors bailing out at the wrong time then the diversification benefits that come from overseas markets will be lost if investors cannot stay the course. For investors who use a financial adviser the currency conversation is a good one to put on the agenda. Not because they can reliably forecast where the currency will be in the future but rather because there are a range of managed fund products - both hedged and unhedged - that can be used to mix and match to suit your personal risk tolerance level. By Robin Bowerman
Smart Investing
Principal & Head of Retail, Vanguard Investments Australia9
22nd July 2013
10th-August-2013 | 
