A strong US dollar and a plummeting Australian dollar have acted as a tailwind for the Growth Portfolio, with currency hedging maximising investor returns
Here at Kauri Asset Management, one of the things we have emphasised in recent times, and particularly in our recent commentary, is the need to have a flexible and agile response to how we manage our International Growth Portfolio. In fact, this is one of our key investment principles.
Hedging plays a crucial role in this approach, and while we often achieve that through various financial instruments, our foreign currency strategy plays a significant role in helping to preserve the value of our portfolio.
With the base currency of the portfolio measured in AUD, and portfolio holdings denominated in USD, even in tough market conditions we have the potential to outperform, just as we did last month. Following our liquidation of all equity positions in late February, we received settlement of cash funds in USD. Since then, this move has worked considerably in our favour and delivered large gains for clients as the Australian dollar plummets.
Why we rotate into USD cash in times like this
To better understand this, it’s important to acknowledge the role that the greenback plays within a volatile environment. The US dollar is considered a ‘safe haven’ currency, along with the likes of the Japanese yen and Swiss franc.
In times of crisis and uncertainty, where markets start to tumble, the US dollar is often afforded a position of desirability because of the low risk associated with it. This comes from the perception that the US is home to a more robust economy, a stable government, as well as the currency’s dominance in the universal global payments scene.
With this in mind, like any other safe haven investment, our decision to shift towards USD cash is a deliberate part of our investment process. We look for such opportunities that will invariably protect the portfolio from market downswings.
In this instance, it means that when things in the market begin to look ugly, we don’t hesitate to press the sell button or adopt other hedging strategies. We can take confidence that our safe haven currency will work in favour of the portfolio, as has been the case in recent weeks.
How the declining Australian dollar has helped the portfolio
As the International Growth Portfolio is funded in Australian dollars, and the underlying equities are denominated in USD, portfolio profits are exposed to fluctuations in the USD/AUD foreign exchange rate. Our hedge offers upside when the Australian dollar is falling, since it means the value of our USD holdings will be worth more once converted back into our local currency.
If we reflect on the performance of the portfolio during February, an increase in the USD/AUD foreign exchange rate from 1.4951 to 1.5363 directly supported the resilience of the portfolio. Directly, this move contributed 3.1% NAV growth. More importantly, these gains effectively offset the equity losses that took place as the market turned sour.
Since then, the USD/AUD exchange rate has touched as high as 1.80, before settling in recent days in the low-to-mid 1.70s. Clients can expect that the strong performance of the USD bodes well for March’s portfolio performance. In many respects, during a downturn this approach is not only a ‘defensive’ portfolio strategy, but it can function as another way for us to passively grow net assets.
Managing currency fluctuations from here
Back in December we forecast that the Australian dollar was likely to come under pressure in 2020, and even before the Coronavirus strangled markets, this projection was playing out. Given the USD/AUD rate has continued to strengthen, one thing we will closely monitor is the emerging impact that the Coronavirus has on the US economy.
In the height of both the Dot-com bubble and the GFC, the US dollar initially outperformed on account of its safe haven status. However, as those recoveries began, the Australian dollar started to pare its losses and rally off its lows.
With the economic impact of the Coronavirus only just starting to unfold, including the prospect that the pandemic could weigh on the global economy for an extended period, we expect the USD will continue to remain strong in the short-to-mid-term. By the time an economic recovery does start to play out, however, we are likely to be reinvested in equities by then.
It is this agile approach to our investment strategy that offers exposure to both a market downfall and rebound.