Hedging explained, is it worth the fees and when it makes sense with Cameron Gleeson

Cameron Gleeson (0:00)

You've chosen a market that's appreciated in its own currency, but the Australian dollars wiped out all your gains.

Alec Renehan (0:05)

Up 21.2%, the unhedged version up 10.4%. So it's cut your return in half.

Cameron Gleeson (0:12)

It's very hard to predict. I think harder to predict than what equity markets are going to do.

Alec Renehan (0:16)

Do you see a lot of investors and advisors go sort of like half-hedged, half-unhedged, or is that just sitting on the fence?

Cameron Gleeson (0:22)

In truth, it is subjective. There isn't actually a right number. It's all a matter of judgment.

Bryce Leske (0:29)

Welcome to another episode of Equity Mates, a show where we explore what's possible in the world of investing. If you've just joined us for the very first time, a huge welcome to our community. My name is Bryce.

Alec Renehan (0:40)

I'm Ren, and today we are talking about currency hedging. It's a question that a lot of investors have as more and more ETFs come to market that have hedged and unhedged versions. So today we're going to unpack what it means and how you can navigate that choice.

Bryce Leske (0:54)

To help us through it, we have back in the studio, Cam Gleeson from Betashares. Cam is a Senior Investment Strategist. Cam, welcome.

Cameron Gleeson (1:00)

Guys, thanks for having me again.

Alec Renehan (1:01)

Now, Cam, you're a great person to talk currency hedging because you actually introduced Bryce to one of his few successful trades in 2020

Bryce Leske (1:08)

That's not true. It's actually probably one of the poorer performing, no, HJPN.

Alec Renehan (1:14)

Yeah, the yen carry trade.

Cameron Gleeson (1:16)

Yes, very sophisticated. Bryce there, that's a good one.

Bryce Leske (1:19)

Anchor of my portfolio.

Alec Renehan (1:21)

So we thought rather we don't want to do the full episode on the yen, but we thought we would zoom out a bit and understand currency hedging because these days, there's so many ETFs and for a lot of ETFs, there's a hedged and an unhedged version. So let's talk about it.

Cameron Gleeson (1:36)

Yeah.

Alec Renehan (1:37)

Let's start general. For Australian investors investing overseas before currency hedging, what currency risk or what currency opportunity were they taking on?

Cameron Gleeson (1:47)

Yeah, so when you're building a portfolio, most Australians will obviously have some Australian shares and then they might have some shares in global markets. So for example, you might have a global equity portfolio, but that might well have a large allocation, say, US stocks.

Now, if we think about what that exposure and the opportunity for risk and return that that provides, essentially that basket of stocks appreciates in US dollars, then hopefully you're going to see a positive return. But the other thing to consider is, well, what's the value of that US dollar return in Australian dollars? So in simple terms, if you had $100 of US shares, and the Australian dollar was to appreciate against the US dollar, the value of those shares in Australian dollar terms, in the terms that you care about, will actually go down. So it's like another lever to your overall return, where you might have picked the right shares to invest in, but unfortunately our currency has appreciated, and that's eroded your own wealth, which is something to be mindful of.

Bryce Leske (2:48)

So Cam, could you explain the difference with a very simple example? If an overseas share price stays flat, but the Aussie dollar rises, what happens to the unhedged investment? And then vice versa, what if the Australian dollar falls?

Cameron Gleeson (3:02)

Yeah, yeah, okay. All right. So if we think about this, and I'll sort of invert exchange rates, because that makes it a little bit easier, but let's just say you have $100 of US dollar assets, and let's just say that the exchange rate right now is for every $100 of US assets you hold, that the current exchange rate is you get $140 in Australian dollar terms. Now, let's think about what happens if the Australian dollar depreciates or falls in value. Essentially, what it means is your $100 of US assets are now worth $150 in Australian dollar terms. So it's actually good news.

In terms of that particular asset, you've actually got more wealth in Australian dollar terms.

Conversely, if the Australian dollar was to appreciate, now those foreign assets are worth less, and assume that exchange rate goes from $140 Australian dollars for the $100 US dollars, that might see the Australian dollar appreciate to essentially only be able to extract $130 in Australian dollar terms for that asset. So it's somewhat counterintuitive because we think, well, if the Australian dollar is appreciating, it's a good thing. It is if you're going on holiday. It isn't necessarily the case if you're thinking about your investment portfolio.