Hedging Currency Risk for Australian Dollar Based Investors. Insight Investment

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1 Hedging Currency Risk for Australian Dollar Based Investors Insight Investment Adam Kibble

2 12/92 12/93 12/94 12/95 12/96 12/97 12/98 12/99 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/10 12/11 12/12 12/13 12/14 12/15 12/16 12/17 Interest rate differentials are an important driver of currency returns Returns Insight's AUD Carry Factor Insight's AUD Carry Factor Source: Insight Investment

3 Frequency AUD/USD month return distribution conditional on carry Conditional Return Distribution 18% 16% 14% 12% 10% 8% 6% 4% Carry Level Ave Monthly Return Monthly Volatility Negative (<0%) Low (0-2%) Medium (2-4%) High (>4%) -0.73% 0.24% 0.41% -0.07% 2.88% 2.90% 3.42% 4.06% 2% 0% -25% -20% -15% -10% -5% 0% 5% 10% 15% Monthly Returns AUD/USD Skew Negative Small Medium High Source: Insight Investment, January 1995 to Dec 2017

4 Current Account Deficit as a Percentage of GDP P e r c e n t o f G D P 0.0% -1.0% -2.0% -3.0% -4.0% -5.0% -6.0% -7.0% -2% -1% 0% 1% 2% 3% 4% 5% C a s h D i f f e r e n t i a l I n v e r t e d -8.0% 6% %age of GDP IR Diff Source: ABS and Bloomberg

5 01/91 02/92 03/93 04/94 05/95 06/96 07/97 08/98 09/99 10/00 11/01 12/02 01/04 02/05 03/06 04/07 05/08 06/09 07/10 08/11 09/12 10/13 11/14 12/15 01/17 02/18 Diversification of Foreign Currencies 12 month rolling correlation of monthly returns between MSCI World and AUD/USD The diversification benefits of foreign currency exposure declines as AUD interest rate differentials narrow Source: Insight Investment

6 Reducing Currency Hedges Increases Risk For equity exposure: Reducing hedges increases volatility you add currency volatility to the equity volatility Correlations matter: Historically since the float if the AUD and MSCI World correlation is above 0.4 diversification is working, below 0.4 the volatility is additive Beware of lower correlation: Do not assume that AUD correlations are constant, as lower interest rate differentials changes the AUD s risk profile Use Dynamic Hedging process: Greater uncertainty around these assumptions means a dynamic hedging strategy acts as an insurance policy to increase hedges from tactical levels

7 Source: ABS Australia s Exports by Region and Country 1998

8 Source: ABS Australia s Exports by Region and Country 2017

9 31/12/ /03/ /06/ /09/ /12/ /03/ /06/ /09/ /12/ /03/ /06/ /09/ /12/ /03/ /06/ /09/ /12/ /03/ /06/ /09/ /12/ /03/ /06/ /09/ /12/ /03/ /06/ /09/ /12/ /03/ /06/2018 Australian dollar and Chinese renminbi USDCNY / USDAUD Correlation correlation Source: Bloomberg and Insight Investment

10 Default currency position 40% 20% 0% -20% -40% -60% -80% -100% -120% 40% EM Currency Exposures: AUD Investors 'AUD' 'CAD' 'CHF' 'EUR' 'GBP' 'JPY' 'USD' 'BRL' 'CNY' 'INR' 'KRW' 'MXN' 'RUB' 'ZAR' 'TWD' 100% short Australian dollar v Exposures from Underlying EM investments Diversified currency position 20% 0% -20% -40% -60% -80% -100% Source: MSCI and Insight Investment 'AUD' 'CAD' 'CHF' 'EUR' 'GBP' 'JPY' 'USD' 'BRL' 'CNY' 'INR' 'KRW' 'MXN' 'RUB' 'ZAR' 'TWD' Equal weight short Developed Markets v Exposures from Underlying EM investments

11 Correlation Australian dollar correlation with EM MSCI currency basket Source: Bloomberg and Insight Investment

12 Disclosures This document is a financial promotion and is not investment advice. This document must not be used for the purpose of an offer or solicitation in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or otherwise not permitted. This document should not be duplicated, amended or forwarded to a third party without consent from Insight Investment. In preparing the report Insight Investment may have relied on information provided by third parties. Whilst Insight Investment have no reason to doubt the accuracy of information used to prepare this report, Insight Investment do not represent, warrant or guarantee that this information is accurate, complete or suitable for any purpose and it should not be used as a basis for investment decisions. Any opinions and estimates expressed in this document are those of the Insight Investment specialists and research analysts and do not necessarily represent the views of the Insight Investment. They reflect the Insight Investment specialists and analyst's judgement as of the date of its publication, they involve a number of assumptions that may not prove valid and are subject to change without notice. Insight Investment is not responsible for any subsequent investment advice given based on the information supplied. Past performance should not be taken as an indication or guarantee of future performance and no representation or warranty, express or implied, is made regarding future performance. Portfolio holdings are subject to change at any time without notice. The value of investments and the income from them can fall as well as rise and investors may not get back the full amount originally invested. Neither the performance of the investments discussed nor the payment of any income return or the return of any capital is guaranteed by Insight Investment or any related body corporate. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading results/returns. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. This material is for wholesale investors only and is not intended for distribution to, nor should it be relied upon by, retail investors. If this material is used or distributed in Australia, it is issued by Insight Investment Australia Pty Ltd (ABN , AFS License No ) located at Level 2, 1-7 Bligh Street, Sydney, NSW 2000 Both Insight Investment Management (Global) Limited and Insight Investment International Limited are exempt from the requirement to hold an Australian financial services license under the Corporations Act 2001 in respect of the financial services; and both are authorised and regulated by the Financial Conduct Authority (FCA) under UK laws, which differ from Australian laws Insight Investment. All rights reserved.