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C & D

Currency – to hedge or not to hedge?

As New Zealand is a small export orientated country, most of our exports are not sold in New Zealand dollars. The New Zealand dollar tends to fluctuate considerably. There is little that New Zealand can do to protect our currency from fluctuating significantly. When there is a global hiccup, there is a flight to the so-called safety of the US dollar. With BRIXIT, the GBP fell considerably lowering farmers’ returns for lamb.

It is all very well trading products in other countries, but we do much of our consumption (spending) in New Zealand dollars. In order to have more predictable sales in New Zealand dollar terms, exporters tend to hedge the currency.

The nature of currency risk is such that there is no reason to believe that there are any extra returns to be earned for taking it on. If there was a currency risk premium, then a US investor investing in NZ cash should get a higher return than if they were invested in a US cash account.

Similarly a New Zealander investing in US$ should expect their US$ account to outperform their NZ account. Both cannot be right. Over the longer term it should not make much difference if an investor or exporter is hedged or un-hedged.

Hedged returns are simply the difference between interest rates in the home country less the interest rates in the currency we are hedging to. For example interest rates in New Zealand are around 2% higher than in the United States. So by fully hedging we should get around a 2% higher return in New Zealand dollar terms. However there is a cost involved in hedging, and it is difficult to maintain a fully hedged amount as markets go up and down.

Within investment portfolios, hedged international shares tend to have lower short term volatility. A 50/50 hedging strategy is best as it reduces the big risks. It halves the impact of short term currency movements. It halves any

long-term impact and it reduces the biggest currency risk of all, which is changing the hedging policy at the worst possible time.

A skilled, experienced adviser should be able to devise a cost-effective strategy to ensure that your international share exposures are hedged to an appropriate level to meet your future lifestyle needs.

Over the years, we have seen several investment managers attempt to play the currency game. Invariably they are losers when it comes to active currency management. It would be useful to investors and advisers alike, if managers reported how much of a contribution their currency management made to their overall returns.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Whakatane based Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.