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Large movements in the Australian dollar can allow investors to reposition portfolios. When it comes to exchange rates, the old maxim ‘what goes up must come down' may be relevant
Brad Matthews
Hillross
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Those who believe in the theory of ‘purchasing power parity' (PPP) would suggest that ultimately market forces will bring about a depreciation in the Australian dollar from current highs. The average value of the dollar over the last 10 years has been 73 US cents, which is only marginally above the calculations of the average rate that should have prevailed if the theory of PPP held.
If investors do have an expectation that the Aussie dollar will ultimately revert to a lower level closer to PPP, there are a number of strategies that could be considered to position part of a portfolio to take advantage of this:
FOREIGN CURRENCY CASH
This is possibly the most straightforward way of gaining foreign currency exposure (and therefore benefiting from a fall in the Australian dollar). However, there are significant storage risks associated with this strategy. In addition, because the cash is not earning any income, the loss of potential investment earnings over time could negate any currency-related benefits.
FOREIGN CURRENCY BANK ACCOUNT
This strategy solves the storage risk problem of holding cash. However, as most overseas interest rates are generally very low at the moment, foreign currency accounts will tend to offer very low or zero interest rates - again, eroding the real value of an investment over a period of time.
UNHEDGED OVERSEAS EQUITY VEHICLES
These will provide investment upside if the Aussie dollar falls but also provide exposure to the returns and risks of overseas share markets.
UNHEDGED CHINESE OR HONG KONG EQUITY VEHICLES
This is a variation on the previous strategy, providing a regional focus around China. Because the Chinese yuan and Hong Kong dollar are closely ‘pegged' to the US dollar, the Aussie has recently appreciated sharply against these Chinese currencies.
GOLD
Investors not wanting to increase exposure to overseas share markets could consider investment vehicles with an exposure to gold. All else being equal, a fall in the Aussie dollar would increase the value of gold in Australian dollar terms as gold prices are set on global markets and quoted in US dollar terms. This strategy, however, exposes the investor to movements in the price of gold, which can be a highly speculative asset that produces limited or no income.
UNHEDGED PROPERTY OR INFRASTRUCTURE INVESTMENTS
These could be a consideration for investors looking for exposure to assets that are likely to produce a reasonable rate of return over the longer term, without the same expected volatility as equities or gold.
Market snapshot
AUSTRALIAN EQUITIES: OVERWEIGHT
In addition to share market valuations still appearing cheap relative to a buoyant economic back drop, confidence in Australian equities is enhanced by the likely resilience of the Australian economy to any further global shocks. Strengthening banking sector profitability combined with current interest rate and currency settings provide key sources potential ‘stabilisers' in the event of a future deterioration in the global environment.
INTERNATIONAL EQUITIES: NEUTRAL
The rally on global equity markets over October has reduced the valuation discounts that were previously available. Global markets remain susceptible to various sources of potential instability, which can be managed, in part, by having an element of unhedged currency exposure in global equity investment vehicles.
PROPERTY: UNDERWEIGHT
Policy fuelled purchases of ‘safe haven' assets have spilled over to US real estate trusts in recent months, which are now expensive relative to underlying property valuations. Australian listed property looks more solid on a valuation basis.
FIXED INTEREST: UNDERWEIGHT
Bond yields are below historical ‘fair value' levels and do not provide compensation for the inflationary risks of a strong domestic economy. Opportunities remain in credit, which appears superior to sovereign debt calculated on a risk adjusted basis.
ALTERNATIVES: NEUTRAL
Given the fine balance between inflationary and deflationary forces, a neutral exposure to inflation sensitive assets such as infrastructure and commodities is warranted. With ongoing disparity in valuations, higher than normal returns may be available to absolute return managers.
AUSTRALIAN CASH: OVERWEIGHT
With the yield curve relatively flat, the prospect of higher cash interest rates suggests that short term cash styled investments should be preferred to longer term fixed interest investments.
