One of the key drivers of Australia’s quarter of a century without a recession is the free float of the currency. That’s because in leaving it to its own devices, moving up or down, the Reserve Bank gets assistance in its monetary policy management of the economy as the dollar either tightens or loosens monetary conditions within Australia.
But what makes life easier for the Reserve Bank and helps keep the Australian economy on an even keel makes life a little more difficult for Australia’s vast army of investment managers.
That’s because Australia’s massive funds management industry has a pool of savings that is too big to deploy effectively in the local economy. By necessity Australian investors, and their investment managers, need to put money to work offshore, buying foreign stocks, bonds, and infrastructure assets.
That also means that one of the biggest decisions managers can make when they deploy their capital is exactly what they are going to do about managing Australia’s volatile currency. Indeed, the volatility of the Aussie dollar can, in some instances, like bonds and infrastructure, overwhelm the returns generated by the assets in which the manager is invested.
That means that while a foreign bond, stock, stock index or other asset will generate a return in its local own currency (say the US dollar) that return can either be amplified or diminished when it’s converted back to Australian dollars.
For example a 10% return in the S&P 500 sounds great but if the Australian dollar has risen 5%, 10% or 20% over the same time the investor’s return is diminished and may even turn into a loss. On the other hand over the past two years when the Aussie dollar has fallen more than 20%, an unhedged exposure to the movements in the Australian dollar would have supercharged returns when converted back into Aussie dollars as the Aussie dollar value of assets, and their income stream, held offshore increased as the Aussie fell.
To repeat, that’s if the money manager was unhedged and reaped the benefits of the Australian dollar’s big fall.
This is all a really long-winded way of saying if you screw up the currency you can screw up the return.
In order to gauge the attitude of Australia’s money managers to how they approach this vexed question of currency management the NAB has recently conducted the seventh in its series of surveys of Australian super funds it conducts every two years in order to provide “clarity about how Australian super funds manage currency – particularly in response to a changing Australian dollar.”
The survey of 40 industry and private funds managing $682 billion in assets shows that besides the difficulty in managing some aspects of currency exposures within emerging markets, two things stand out in the survey’s results:
- The first is that money managers are increasingly taking back the management of the currency directly into their investment committees. The NAB said “56% of funds, the investment committee now has the most influence on currency issues, back to 2005 levels.” That means that the firms managing the currency on a monthly basis has risen from 5% in 2013 to 24% in 2015. Not exactly trading but it sounds like something closer to it.
- Second, after two years of falls, and even though 63% of respondents still expect the Australian dollar to head lower, an increasing number of funds think the rout is over.
The NAB said (emphasis added):
Despite the view that nobody can predict the currency, each respondent in the 2015 survey had a view: and 63% believe the AUD will continue to go down over the next two years.
A slight increase on the last survey (20%) said they saw no change in the AUD, from 16%. However, what was interesting was the increase in those who now see an increase in the AUD/USD over the coming two years. Approximately 17% now see a rise in the AUD in the years ahead, up from 9%, highlighting an increase in dispersal of views.
This is surprising in the context of the broad market bearishness on the Australian dollar at present. Measures of market views show the IMM speculative traders remain quite short, while measures of net fund flows also show outflows in Australian assets and few domestic purchases. This is also consistent with the fund survey results of a rise in FX exposure. If 17% really do believe that the AUD is headed higher than its current levels, we may start to see more hedging by the time the next survey comes around.
If they are right, let’s hope Australian funds get busy and start hedging their offshore exposures.
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