Hedging Currency Risk for Australian Dollar Based Investors Insight Investment Adam Kibble +612 9260 6657 adam.kibble@insightinvestment.com
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 0.6 0.5 0.4 0.3 0.2 0.1 0-0.1 Insight's AUD Carry Factor Insight's AUD Carry Factor Source: Insight Investment
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 0.4 0.2-1.6-1.0 Negative Small Medium High Source: Insight Investment, January 1995 to Dec 2017
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 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
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 1 0.8 0.6 0.4 0.2 0-0.2-0.4-0.6-0.8 The diversification benefits of foreign currency exposure declines as AUD interest rate differentials narrow Source: Insight Investment
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
Source: ABS Australia s Exports by Region and Country 1998
Source: ABS Australia s Exports by Region and Country 2017
31/12/2010 31/03/2011 30/06/2011 30/09/2011 31/12/2011 31/03/2012 30/06/2012 30/09/2012 31/12/2012 31/03/2013 30/06/2013 30/09/2013 31/12/2013 31/03/2014 30/06/2014 30/09/2014 31/12/2014 31/03/2015 30/06/2015 30/09/2015 31/12/2015 31/03/2016 30/06/2016 30/09/2016 31/12/2016 31/03/2017 30/06/2017 30/09/2017 31/12/2017 31/03/2018 30/06/2018 Australian dollar and Chinese renminbi 0.9 0.8 USDCNY / USDAUD Correlation 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0-0.1-0.2 correlation Source: Bloomberg and Insight Investment
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
Correlation Australian dollar correlation with EM MSCI currency basket 1 0.8 0.6 0.4 0.2 0-0.2 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Bloomberg and Insight Investment
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