The strength of the Australian dollar compared with other currencies creates opportunities for investors in international assets.
But in order to manage risk, investors need to understand the potential impact of future currency movement on their investments.
A strong Australian dollar means investors have greater purchasing power when buying international assets.
However, once the initial investment is made, currency movement can influence returns from capital growth, dividend or interest payments, bringing both upsides and downsides.
This needs to be considered carefully before such investments are made.
If our dollar depreciates, currency gains can be made when unhedged international assets are converted back to Australian dollars.
However, if the Aussie dollar appreciates, investors will experience currency losses that reduce returns. They may even end up with substantial losses.
To help manage this, investors can choose to hedge against movements in the local currency, remain unhedged, or partially hedge their international exposure.
Hedging the currency exposure will protect investors from currency losses with a rising Australian dollar, but hedging costs will erode some of the currency gain if the value falls.
Many investors opt for a combination of hedged/unhedged international exposure, which helps to mitigate some of the risk and potentially enhance returns.
Predicting currency movements has proven to be very difficult and there is always some risk involved.
Whether investors should hedge, not hedge, actively hedge, or some combination of these options, is dependent on their own risk profiles.
Nonetheless, if investors are concerned about the risk of a continued rise in the Australian dollar, they should consider hedging some or all of their currency risk.
This can be done by either:
> Investing in a managed fund that actively manages the currency exposure, thereby leaving the hedging decision to the fund manager
> Investing in a managed fund that has a set amount of hedging in place at all times, such as 50% and 100% hedged international share funds.
Given current market volatility and uncertainty, currency hedging decisions can significantly influence the performance of investment portfolios.
They can be used to protect gains in international assets as well as to help minimise the risk of losses caused by currency fluctuations.
Darren Matthew is a partner at accountancy and financial advisory firm, HLB Mann Judd, in Adelaide.