How do foreign exchange fluctuations impact Australian investments?
Foreign exchange risk (or currency risk) is the financial risk of an investment’s value changing due to the changes in currency exchange rates1. Any time you invest in an asset with an overseas connection you will be exposed to foreign exchange (or FX) risk. It doesn’t have to be an overseas asset either. Investment in any company with overseas involvement as an importer or exporter of raw materials, or finished goods will have an exposure to the currencies of its overseas clients and suppliers. Exchange rates are influenced by many different factors, Investopedia sums them up rather well in this video.
In many cases, companies with foreign exchange risk will seek to reduce their exposure by hedging their risk. Many companies have treasuries devoted to the job of reducing their exposure to financial risks including foreign exchange and interest rate risk.
Large Super Funds, unless specified as Australian only, will also make purchases in overseas investments. They don’t have much choice in many cases, for property unit trusts, and shares, the Australian market is small and there are far more options to choose from in overseas markets2.
Due to its location, geography and relatively small population, Australia imports and exports many goods and services. As an Australian investor in shares, property or cash you will most likely have some exposure to FX movements.
Investments in shares
Even when you invest in an Australian company, there’s still a solid chance you’re investing in a company with overseas influences. An article on The Conversation, describes four Australian companies from widely differing industries, all of whom could be vulnerable to movements in the Australian dollar (AUD).
The Conversation also pays attention to the fact that the AUD is what’s known as a ‘commodity currency’ or one that is closely aligned with commodity prices. The New Zealand and Canadian dollar are also considered to be commodity currencies3.
It refers to the financial reports of Qantas, JB Hi-Fi, Evolution Mining and Carsales.com. Both Qantas and Evolution are heavily involved in commodities, Qantas is a big importer of oil (and also of aircrafts) and Evolution’s success is strongly tied to the price of gold. Both mention foreign exchange fluctuations in their report.
JB Hi-fi is a large importer of foreign products and as such will pay more if the AUD weakens. Carsales is trying to break into overseas markets and is exposed to how the AUD moves against the currencies of Latin America and Asia.
These four very different Australian companies are all vulnerable to foreign exchange movements. Only Qantas and Evolution make much mention in their annual reports, JB mentions its hedge fund which is designed to absorb FX fluctuations and Carsales reports a loss of $1.3m due to ‘translation of foreign operations’. Neither JB or Carsales speaks of future FX risks, while Evolution and Qantas both refer to them3.
If you want to be reassured (or otherwise) about your intended investment’s approach to FX risk, their financial reports would be a good place to start.
Investments in a Superannuation Fund
If you’re a member of a large Super Fund with a balanced or growth investment option, at least 20% and up to 35% of your super money may be invested in international shares. Your funds may also be invested in International Listed Property (Real Estate Trusts or REITs) and International Fixed Interest Investments2.
Trish Power from Superguide warns that up to 80% of members of Super Funds don’t specify their investment options, leaving them potentially exposed to foreign exchange risk they’re potentially not aware of. She recommends always making an active decision on your investment options2 when you join a Super Fund. Your financial planner can help you with this.
Investments in property
Overseas properties will always change in value as foreign currencies move against one another. Property overseas (whether an individual property or a part of a REIT) will be subject to the various risks of overseas investments including country, political, regional and currency. On top of this are the actual risks of the asset. As an investor, it’s good to know whether you’re exposed to these risks before you choose to invest, so ask lots of questions of your fund manager or your financial planner.
As the AUD rises and falls, the value of the investment goes up and down, regardless of the changing value of the underlying asset. If the FX is hedged then any movement in the value of the asset is related to the asset itself, not currency movement.
Of course, it’s up to you whether you hedge foreign exchange risk or not. There is a cost to hedging, to purchase the derivative that provides the hedge. It provides certainty and removes risk, leaving you exposed only to changes in value of the underlying asset.
Investments in foreign cash
Should you choose to invest in foreign currency, at least you are clear on the fact that you intend to be impacted by FX rates. There is quite a different mind-set to openly embracing the decision to expose yourself to foreign exchange risk versus having FX risk as an indirect risk, embedded in an investment you make.
FX risk is something we all live with
It’s hard for any Australian investor to escape the impact of FX risk. Even in our daily lives the products we buy, wear, eat or drink are often sourced from overseas or manufactured overseas, or part owned by an overseas company. Movements in foreign currencies can change the price of the products we buy or the value of the investments we make.
Rather than avoid foreign exchange risk, it’s probably wise to accept it’s a part of life in Australia. Even buying shares in an all Australian company is unlikely to avoid FX because many companies are importers or exporters of products or raw materials or even have part of their workforce overseas. Australian property and Australian infrastructure are possibly your best bet for an FX free risk asset class. Why not ask your financial adviser to give you their viewpoint how much currency movements impact on your investments. Contact our planners at Modoras on 1300 888 803.
Over to you. Have you been burnt by foreign exchange fluctuations? Do you accept a little FX risk in your life as normal?
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