It was interesting to look back at the corresponding edition last year - 30th October 2008.  In that edition we were looking at exchange rate movements with some talk in the press about the Australian dollar reaching parity with the US dollar.  Well we now know that it nearly got there reaching a peak of 98 cents in July 2008.  By October 2008 it was sitting around the 60 cent mark as investors took flight back to the safe haven US dollar and now it has risen strongly back to just over 90 US cents to the Aussie.
 
In this edition we revisit the relationship between the Australian dollar and other currencies and how movement in the Australian dollar impacts on investments.
 
The recent movements in the Australian dollar compared to other currencies has seen a significant appreciation in value across the board.  Since markets turned at the beginning of March we have seen it increase:
 
There can be many reasons for movements in the value of a currency but the basic story is about supply and demand.  Since December 1983 Australia has used a floating exchange system.  Under this system changes in demand and supply of a currency affect its value.  Demand for the Aussie dollar is affected by
 
Supply on the other hand is represented by:
 
Given the recent appreciation of the $A there appears to be greater pressures on the demand side of the currency which has forced the exchange rate upwards.  A couple of key theories that are being suggested as a cause:

i)The Aussie dollar is seen as a commodity currency as the Australian economy is heavily reliant on the sale of commodities.  As the prices for these commodities rise so to does the exchange rate.

ii)The Reserve Bank has started to lift interest rates and our rates are much higher than other developed economies such as the UK, US & Japan.  The "Carry Trade" seeks out currencies with higher interest rates which increases the demand for the Australian dollar.
 
These are reasonably simplistic economic theories but seem to make sense given the current markets.
 
What Does This All Mean for Investors?

For mainstream investors (who are not trading currencies) the major implication of changes in exchange rates for investors is that it changes the value of international investments in terms of Australian dollars.  If you bought investments in the US at the beginning of March one $A would have bought you 63.26 US cents of investments.  If you wanted to convert those 63.26 cents back into $A now you would have been able to buy 69.87 Australian cents (at the exchange rate of 90.54).  Without taking into account investment returns and transaction costs you would have lost 30.13 cents on the original dollar.
 
If the dollar was falling in value the opposite would be true leading to a gain.
 
So over the past few months while share markets around the world have been rising strongly, unhedged international share investments have faired worse compared to Australian share investments.

Now if we turned our attention to annual returns to the end of June, an unhedged exposure would have faired much better.
 
Should you be moving to currency hedged international investments?
 
To protect against the negative impact of an appreciation in the Australian dollar compared to other currencies you may think that it is a good idea to employ currency hedging.  What this does is to take out the impact of currency movement.  For example, in US dollar terms the S&P 500 total return has been 49% since the beginning of the turn in markets.  If you had currency hedging in place you would have realised all of that gain whereas with no hedging you would have lost a major part of that gain.
 
This suggests it is a simple decision - put in place hedging when the currency is rising and remove hedging when the Aussie dollar is falling.
 
Unfortunately the ability to accurately time currency movements is even more difficult then trying to time share market movements.

We try not to make bets regarding the movement of ths dollar against other currencies but would throw in this point, with the Aussie dollar fetching over 90 US cents we are at a level well below average.  Since 1983 when the dollar was floated the average rate has been 72 cents.  In recent years this average has tended to be just under 82 cents.  Either way, by locking into a hedged exposure at this point in time you are locking in at a currency level higher than average.  The odds would suggest that it is more likely that the Aussie dollar will fall rather than rise in value over time and this might suggest that now is not the time to be putting in place currency hedged international investments.
 
Our Approach to Currency Hedging
 
In line with our overall philosophy towards investment markets, we do not believe you can time when exchange rates will rise or fall.  Therefore, our philosophy is to incorporate hedged investments in our high yield investments - international fixed interest and listed property.  This protects these more regular and higher income sources from exchange rate movements.  However we also look to expose investment portfolios to some exchange rate risk and diversification through using un-hedged international share funds.
 
This strategy worked well through 2008 but of course does not look so good when the Aussie dollar is rising in value.  Over the long term currencies will fluctuate in value so that there should be no significant difference between holding a hedged v unhedged position.  The only real difference should be the slight extra cost involved with paying for the currency hedging.
 
in a nutshell, as with all investment decisions it really comes down to the individual requirements of each client.