When the falling AUD can benefit your investment portfolio

While the Australian Dollar has been sinking versus the US Dollar for the majority of 2022, many have seen a big hit to the hip-pocket when it comes to the cost of travelling or paying for goods or services from the US.

But for investors whose equity portfolios have strong geographic diversification, a falling AUD historically tends to boost overall portfolio returns and help reduce risk in volatile markets.

Let’s look at how.

If prices of imported goods are rising overseas, the value of any global investments should increase to offset, or hedge, against these rising prices.

In addition, an investor protects against the depreciation of their currency because their overseas assets are now worth more to them when converted into AUD. In this example the strong US dollar will buy more Aussie dollars when converted.

But what’s more interesting is how currency has worked to benefit Australian investors in falling markets.

Historically there has been a strong relationship between the Aussie dollar and global equity markets. With a positive correlation over the last 20 years, the AUD is seen as a ‘risk on’ currency. This means it moves with markets, generally weakening when equity markets fall and strengthening when markets rise.

For a local investor this can be beneficial. When global equity markets fall, a weakening AUD will boost the portfolio return on your overseas equities, in AUD terms.

The two charts to the right illustrate this.

You can see throughout this year (chart on top), as the AUD fell, so did the US stock market.

Between 31 March 2022 and 30 September 2022, the weaker AUD (-14.5%), means the one US dollar of returns earns 14.5% more AUD. Consequently, the US market in AUD terms has only fallen -7%, vs the S&P 500 headline fall of -20.2%.

You can also see a similar result during the 2008 financial crisis bear market (chart on the bottom).

Unhedged can be your friend

While many investors chose currency hedged allocations to hedge away currency risk, we think allocating a portion of your income- generating global equities portfolio to unhedged global equities, can work to buffer against falling markets and imported inflation.

At Plato, our Global Shares Income Fund does not hedge and therefore provides income investors the diversification benefits of exposure to other currencies, given the strong tendency for the Australian Dollar to weaken in times of weak equity markets.

Of course, investing in global shares presents a range of possible risks for a new investor and every investor’s circumstances are different, so one should always seek professional advice.

By Daniel Pennell, Senior Portfolio Manager, Plato Investment Management.