Reducing  risk  in  international  portfolios  
Jon  Howie,  Head  of  iShares  Australia  
 
International  diversification  has  always  been  an  important  consideration  for  Australian  
investors.  The  Australian  investment  landscape  continues  to  evolve,  and  it’s  never  been  
easier  to  access  global  investment  opportunities  than  it  is  today.  But  with  this  greater  access  
and  choice  come  several  questions.  One  of  the  most  important  questions  is  how  to  manage  
the  impact  of  currency  on  a  portfolio  when  investing  offshore.  
 
The  Australian  equities  market  is  heavily  weighted  to  the  banks  and  resources  sector.  While  
the  latter  also  provides  a  proxy  exposure  to  infrastructure  and  construction  in  China,  a  
benefit  when  Chinese  growth  was  surging,  the  outlook  is  for  slower  growth  and  the  result  is  
sharply  lower  commodity  prices,  especially  in  iron  ore.    Yet  sectors  that  are  experiencing  
higher  growth  globally,  such  as  technology  or  pharmaceuticals,  are  not  easily  accessed  via  
Australian  equities.    
 
Further,  an  oft-­‐cited  statistic  is  that  the  Australian  share  market  represents  just  3  per  cent  of  
global  markets,  meaning  that  97  per  cent  of  the  investment  opportunity  remains  outside  
Australia.    This  creates  the  chance  for  investors  to  complement  their  investments  in  
Australian  markets  by  taking  advantage  of  the  diversification  available  in  different  countries  
and  investing  in  the  sectors  driving  the  growth  of  the  Australian  economy.  
 
But  while  diversifying  into  overseas  markets  can  be  a  good  thing,  recent  movements  in  the  
value  of  Australian  dollar  have  led  investors  to  ask  how  to  reduce  the  risk  of  currency  
movements  in  their  portfolio.  Finding  ways  to  reduce  the  impact  of  changes  in  the  value  of  
the  Aussie  dollar  allows  investors  to  focus  on  the  international  markets  likely  to  provide  the  
best  opportunities  over  the  coming  year.  
 
Currency  risk  
Unlike  many  other  investment  options,  the  risk  /  return  tradeoff  with  currency  is  not  clear-­‐
cut.  
 
Most  other  types  of  investment  choices  have  a  clear  risk  /  return  trade  off.  Invest  in  equities,  
for  instance,  and  you  can  expect  higher  returns  than  an  investment  in  say,  bonds,  but  with  
higher  volatility.  Investors  and  their  advisers  take  the  risk  /  return  characteristics  of  an  asset  
class  into  consideration,  and  make  their  investment  decisions  accordingly.  
 
Not  hedging  an  international  investment  exposure  means  investors  are  taking  on  additional  
currency  related  risk  with  no  guarantee  of  increased  returns.  
 
Indeed,  currency  movements  have  both  enhanced  and  diminished  returns  over  the  years.    
 
 
 
 
Why  would  you  hedge  currency  risk?  
 

 
 
The  past  few  years  of  a  consistently  high  Australian  dollar  (AUD)  have  lulled  many  investors  
into  a  false  sense  of  security  when  it  comes  to  currency  risk.    Many  investors  have  forgotten  
the  benefits  of  hedging,  particularly  over  the  past  year  or  so,  as  investors  who  were  not  
hedged  were  better  off.    
 
In  fact,  for  eight  of  the  past  10  years,  investors  have  been  better  off  with  a  currency  hedging  
strategy  than  without  one,  as  the  accompanying  chart  demonstrates.  
And  the  recent  depreciation  of  the  AUD  has  been  a  tailwind  for  Australian  investors  with  
overseas  investments.  
 
To  hedge  or  not  to  hedge?  
Hedging  is  about  providing  a  choice  for  investors.  The  question  for  many  investors  is  when  
should  they  hedge,  and  how  much?  There  is  no  right  answer,  and  the  appropriate  hedging  
ratio  will  vary  over  time,  and  depend  on  on  a  number  of  factors.  
 
Investors  should  consider  a  high  hedging  ratio  when:  
• Currency  volatility  is  high  
• There  is  high  correlation  between  currency  and  underlying  asset  returns  
• There  is  a  high  allocation  to  foreign  investments  
• The  investors  risk  tolerance  is  low  
 
A  lower  hedging  ratio  should  be  considered  when:  
• Currency  volatility  is  low  
• There  is  low  correlation  between  currency  and  underlying  asset  return  
• There  is  a  low  allocation  to  foreign  investments  
• The  investor  has  a  high  tolerance  for  risk  
How  much  should  I  hedge?  
 

 
Source:  iShares  2015    
 
Many  investors  take  the  view  that  there  is  no  reward  for  taking  currency  risk    on  
international  investments,  so  it  is  better  to  remove  that  risk  from  the  portfolio  by  hedging  
out  currency  exposure  and  focus  on  the  stocks  or  markets  themselves.  
 
Ultimately,  the  hedging  ratio  that  advisers  should  recommend  depends  on:  
• Their  client’s  desired  investment  outcomes  
• Their  client’s  sensitivity  to  risk  
• Their  own  degree  of  conviction  about  the  direction  of  the  currency  
   
For  example,  if  a  client  is  extremely  concerned  about  their  international  returns  being  
impacted  by  the  AUD  appreciating  against  the  US  dollar,  a  completely  hedged  approach  may  
be  appropriate.  
   
On  the  other  hand,  if  an  adviser  believes  that  the  Australian  dollar  will  depreciate  against  
the  US  dollar  and  their  client  wants  to  have  an  element  of  exposure  to  that  potential  boost  
to  their  overseas  investment,  a  50:50  approach  may  be  appropriate.  
   
Using  ETFs  
ETFs  provide  a  good  way  for  investors  to  gain  international  exposure  with  just  one  trade.  
iShares’  most  popular  international  ETFs  are  the  iShare  Core  S&P  500  (IVV)  and  the  iShares  
Global  100  (IOO).  In  late  2014,  iShares  launched  currency  hedged  versions  of  these  two  
funds.  The  new  funds  trade  under  the  tickers  IHVV  and  IHOO  respectively.  
 
ETFs  providing  international  exposures  are  popular  with  investors  due  to  their  portfolio  
diversification  benefits.  And  for  investors  who  are  concerned  about  currency  risk,  hedged  
ETFs  are  increasingly  in  demand.  
 
In  a  global  context  of  diverging  monetary  policies  and  economic  conditions,  currency  hedged  
funds,  such  as  IHVV  and  IHOO,  give  Australian  investors  an  easy  and  cost  effective  way  to  
control  the  impact  of  currency  movements  on  their  international  exposures.    
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issued  in  Australia  by  BlackRock  Investment  Management  (Australia)  Limited  ABN  13  006  165  975  AFSL  230  523  (BIMAL).    This  document  is  
intended  only  for  wholesale  clients  and  must  not  be  relied  or  acted  upon  by  retail  clients.  This  document  provides  general  information  only  
and  has  not  been  prepared  having  regard  to  your  objectives,  financial  situation  or  needs.  Before  making  an  investment  decision,  you  need  
to  consider  whether  this  material  is  appropriate  to  your  objectives,  financial  situation  and  needs.  This  document  has  not  been  prepared  
specifically  for  Australian  investors.  It  may  contain  references  to  dollar  amounts  which  are  not  Australian  dollars.  It  may  contain  financial  
information  which  is  not  prepared  in  accordance  with  Australian  law  or  practices.