WEEKLY E-MAIL

25 August 2025

CURRENCY HEDGING YOUR INVESTMENT PORTFOLIO

By James Malliaros

Currency volatility is an ever-present consideration in the globalised world of modern investing. The Australian dollar (AUD), while stable by global standards, is highly sensitive to commodity prices, interest rate differentials, geopolitical developments, and global risk sentiment. For investors with exposure to international assets, fluctuations in the AUD can amplify gains or exacerbate losses. When the AUD strengthens, international holdings may lose value in local terms. Conversely, a depreciating AUD can boost the Australian dollar value of foreign assets. This dual-edged sword creates uncertainty and inconsistency in portfolio outcomes. Understanding and managing this volatility is crucial for preserving wealth and achieving long-term financial stability.

Most global equities and global equity ETFs held by Australian investors are unhedged. In addition, self-directed investors tend to hedge significantly less than those who are advised by a financial planner, where hedge ratios are typically closer to 50%.

With US equities comprising most of the global benchmark, movements in the AUD/USD exchange rate have a major impact on unhedged returns. Over the past decade, being unhedged has provided a tailwind, but this dynamic can reverse – and there are clear historical precedents for extended AUD strength and relatively poor unhedged US and global equity returns.

Since the Australian dollar was floated in 1983, the AUD/USD has averaged around $0.75, and even in the past decade has touched $0.80 on multiple occasions. Analysis has shown that if the AUD were to return to US$0.80, it would reduce the local return on US equities by approximately 20%.

What is hedging?

Simply put, a currency hedge is an instrument that offsets any currency movement effect on the returns of an overseas investment. As a result, investment returns should reflect the actual returns in the overseas country in which they were made, without any additional impact from foreign exchange movements. This gives investors the option of being able to invest offshore without having to worry about adverse currency exchange rate movements impacting their investments.

What is happening now?

The US dollar Index has been falling since the beginning of the year, with a significant fall of 7.0% in the June 2025 quarter alone. This has taken its current drawdown to 11.9%, the lowest level in three years and marks the worst first half of a calendar year since the 1970s for the USD.

This weakness emerged despite the resurgence in US stocks, highlighting the dollar’s decline amid a broader “sell-US trade”. A weaker US dollar is an explicit goal of the Trump administration, and while there is no direct policy to force the dollar weaker, a combination of trade policy uncertainty and expectations of a US growth slowdown are doing the job.

Currently, the scope for continued USD weakness looks likely. Positioning in the USD remains elevated, and on most fundamental currency metrics, such as purchasing power parity, the USD is still considered overvalued. The AUD has also lagged against other currencies in its appreciation against the USD and has room to catch up.

Source: BIS, Russell Investments

These developments could lead to a significant and rapid appreciation of the AUD, which currently remains about 13% below its long-term average of US$0.75. This would have significant impacts on Australian investor returns at a time when they are more exposed to the USD than ever.

Considering a long-term approach to currency hedging

For Australian investors, leaving a portion of your global equities exposure unhedged can lower portfolio volatility and drawdowns in periods of strong equity market downturns.

This is because the AUD is seen as a “risk on” currency, whereas the US dollar is often regarded as “safe haven” currency, which historically has tended to appreciate in periods of market sell-offs.

As shown in the chart below, during the Covid-19 pandemic market sell-off in March 2020, an unhedged global equities index experienced a smaller drawdown (-20%) compared to a hedged index (-33%).

Source: Bloomberg. 31 January 2020 to 1 June 2020

As such, investors always need to consider not only whether the global asset they are invested in will generate a return, but also whether exchange rates will move in their favour, or against them. This is why many investors opt for some form of currency hedging to reduce the impact of currency fluctuations on their portfolio.

Historically, the data has shown that being completely unhedged or 100% hedged increases the return outcome uncertainty. Where the level of currency hedging employed was between 30% and 80%, there was far lower variability between the minimum and maximum five-year return outcomes.

The balance of risks seems to be skewed toward USD weakness over the medium-term. It appears to be historically expensive, and there are indications that global investors are hedging their exposure to US dollar-denominated assets. Given the outlook for a weaker USD, we think that there is a strategic case for a partially hedged position to the US dollar and having a globally diversified portfolio.

James Malliaros
Senior Financial Planner
Certified Financial Planner®
SMSF Specialist Advisor™
Authorised Representative No. 291633

If you have any questions or comments, please email me at james@gfmwealth.com.au

Disclaimer: This document is not an offer or invitation to any person to buy or sell any interest in or deposit funds with any institution.  The information here is of a generic nature, and does not take into account your investment objectives or financial needs.  No person should act upon this information without firstly seeking competent, professional advice specifically relating to their own particular situation.

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