Of course, predicting the likely direction of exchange rates is no easy feat and speculators often get it wrong. This is hardly surprising given the number of different factors at play at any point in time. These can include: commodity price movements, comparative international interest rates, current account deficit levels and central bank interventions in currency markets.
The graph below illustrates the Australian dollar's rises and falls against the US dollar since it was floated in 1983.
Source: Reserve Bank of Australia
What does the higher Australian dollar mean for investors?
International exposure forms an important part of a diversified portfolio strategy for many Australians. The level of exposure to overseas equity, property and fixed interest markets usually depends on the risk/return profile of the investor and personal preference.
While the higher Australian dollar increases our purchasing power of overseas products and services it can play havoc on the investment returns of assets denominated in foreign currencies. When the value of the Aussie dollar rises the value of the foreign assets fall in value when converted back into the investor's currency. Of course, the reverse is true when the Aussie dollar falls in value.
For many investors part of the appeal of investing internationally is the added diversification foreign currency exposure provides, which is why many investors choose an unhedged or partially hedged international equity fund. Unhedged international funds are exposed to currency fluctuations and obtain returns from two sources - the change in value of the investment and the currency returns. As the above chart illustrates sometimes the latter works in your favour and at other times it doesn't.
For investors who find the thought of currency price movements too much to bear there are hedged international funds. A fully-hedged fund provides a buffer against currency fluctuations. In effect, investors get the equity market returns without the currency impact so they don't have to worry about movements in the Australian dollar. As fixed interest is a defensive asset class, international bond funds offered in Australia are typically fully hedged.
With the extreme volatility in equity markets over the last two months the rising Australian dollar is compounding many investors' concerns. Perhaps some of these investors can take solace from history. While in the short term, the currency impact on investment returns can be substantial, it tends to be less apparent over longer time periods. For those who don't want the additional worry of adverse currency movements there is always the hedged option.
Vanguard offers both hedged and unhedged international equity funds. Investors can also gain access to international fixed interest markets through the Vanguard Index Diversified Bond Fund. Find out more
