Subconsciously patriotic: the Kiwi case for diversification into foreign currency
Article written by InvestNow – 3rd August 2022
Whether it’s the All Blacks or Lord of the Rings, Kiwis love seeing NZ represented on the world stage.
And whether they’re conscious of it or not, most New Zealanders are just as patriotic about the home country currency, preferring to earn, invest, and generally think of finances in dollar terms.
The vast majority of Kiwis are paid exclusively in NZ currency with major assets such as property and KiwiSaver also valued and largely invested in local dollars.
NZ is not alone in this natural home-bias: citizens of most developed countries that have stable currencies share an economic and emotional bond with the money they use every day.
However, the subconscious monetary patriotism carries a hidden risk for investors given assets valued in NZ dollars are only one side of the equation.
For example, on the other side of the ledger, a large chunk of normal living costs are ultimately priced in offshore currencies – most notably, the US dollar – covering items such as petrol, cars, medicine, computer equipment, whiteware and other imported goods.
Even home-grown staples like milk and meat are priced in foreign currency terms, reflecting their status as global commodities with prices set by offshore buyers.
The outsize impact of global currency fluctuations on NZ living costs has come home to roost this year amid the soaring value of the US dollar, which has appreciated almost 9% against the Kiwi over the year-to-date and lies about 11% higher than the same time last year.
In essence, the NZ dollar now buys around 10% less of goods priced in US dollar than it did a year ago including a significant portion of everyday imported consumables like petrol, and locally produced beef and dairy.
While the majority of media attention has been focused on petrol prices and $10 lettuces fuelling NZ’s latest 7.3% inflation rate (a 32-year high), the negative impact of a lower Kiwi dollar on the country’s overall wealth has largely escaped the headlines.
Both sides of the coin: why wealth is local and global
Consider the example of the average balanced KiwiSaver fund, which returned roughly -10% in NZ dollar terms for the last 12 months (many funds performed below this level with a wide spread of returns over this period).
For US investors owning this same average balanced fund, their return would have been more like -21%, accounting for the fact that most of these assets were anchored to the poor-performing Kiwi dollar. Conversely, over the last year, Kiwi investors have experienced just as poor a return (expressed in US dollar terms), but the fact may have passed them by.
Of course, in reality the fundamental return of the fund hasn’t changed but the currency basis has a strong influence on reported performance.
The same logic applies to other parts of the Kiwi economic equation. For instance, if the hypothetical American investor owned a house here while earning a salary in NZ dollars, both income and property values would have depreciated by around 11% over the year as a result of the dip in our currency.
And here’s the rub – the above scenario actually happened: Kiwis got materially poorer over the last year because of the decline in the NZ dollar. However, most New Zealanders are blissfully unaware of their falling wealth because it is typically reported in local dollar terms.
But by assuming the perspective of a US person owning NZ dollar-denominated assets, the scale of the wealth reduction – and the risks of home currency bias – rapidly becomes clear.
Finding the ‘right’ currency exposure for NZ investors, however, also requires viewing both sides of the equation. If the Kiwi dollar is rising, for instance, it’s easy to overlook the fact that our local houses, shares and incomes etc have gone up in value (based on a global view) and focus instead on the shrinking valuations of unhedged global assets in the portfolio.
Clearly, NZ investors can source diversification benefits not just by owning different types of assets but also among foreign currency holdings. On the other hand, those Kiwis with a portfolio skewed to a currency home-bias risk exposure to a loss in overall purchasing power and absolute wealth, relative to the rest of the world.
The recent experience of Sri Lanka, which has seen its rupee lose 43% against the US dollar since March this year alone, serves as a grim example of home-bias risks in portfolio currency weightings.
Kiwis can at least take comfort that the demise in the NZ dollar in recent times has been less catastrophic.
How to beat home-country currency bias
The recent foreign exchange market volatility – and evidence of how it affects overall wealth – should prompt investors to spend time thinking about currency hedging and its potential impact on portfolio performance.
Furthermore, the real-life experience also helps explain the impact that an investment manager’s currency hedging approach can have on a fund’s overall returns (discussed in further detail in a previous article). Within many diversified managed fund options, a few common approaches to currency management include:
- Hedge out all currency risk by investing in global funds that are 100% hedged to NZ dollar;
- Fully hedge their global fixed income, while only hedging 50% of global equity exposures;
- Not hedging their global share exposures; and,
- Active currency management.
In both the second and third options, an investor’s exposure to foreign currency is a function of the size of their allocation to global shares. Accordingly, an investor with a ‘growth’ strategy fund has more exposure to foreign currencies than their ‘conservative’ counterpart. While this convention prevails across the industry, it is odd or ill-conceived from an investment-purist perspective as foreign currency exposure can be justified in an investor’s portfolio irrespective of the level of global equity assets.
Despite the flawed framework, NZ fund managers nevertheless still seem to flock together in setting currency exposures relative to offshore equities holdings due to comfort reasons (in fact most managers, including the base currency settings on peer group averages).
Kiwi investors, though, might benefit by considering a fifth option: a customised hedging arrangement whereby one holds enough currency exposure to match foreign currency denominated liabilities.
Say an investor put everything into a global shares portfolio and estimated about 40% of their wealth is spent on foreign liabilities: under this scenario, a matching portfolio would consist of global equities investments split 60/40 between hedged and unhedged allocations.
Alternatively, it may make sense for Kiwis to dedicate a portion of their investment portfolios to holding foreign currencies direct, particularly as international borders open up again and travellers look for pragmatic and financially prudent ways to manage cash.
Predicting foreign exchange movements is, however, notoriously difficult even for seasoned professionals but the important lessons from the recent foreign currency market volatility for Kiwi investors include:
- Be mindful of bias towards only thinking in NZ dollar terms – query what any headline numbers actually mean in relation to your purchasing power on a world stage;
- Understand the impact that currency movements can have on overall returns; and,
- Consider the appropriate currency hedging strategy to utilise in investments relative to your individual foreign liability exposures.
Putting this all into practice, InvestNow has a wide range of funds and tools to help Kiwi investors implement hedging strategies to suit their individual circumstances, as well as access to expert insights from fund managers and industry players to guide everyday Kiwis closer towards their financial goals.
Subconsciously patriotic: the Kiwi case for diversification into foreign currency
Article written by InvestNow – 3rd August 2022
Whether it’s the All Blacks or Lord of the Rings, Kiwis love seeing NZ represented on the world stage.
And whether they’re conscious of it or not, most New Zealanders are just as patriotic about the home country currency, preferring to earn, invest, and generally think of finances in dollar terms.
The vast majority of Kiwis are paid exclusively in NZ currency with major assets such as property and KiwiSaver also valued and largely invested in local dollars.
NZ is not alone in this natural home-bias: citizens of most developed countries that have stable currencies share an economic and emotional bond with the money they use every day.
However, the subconscious monetary patriotism carries a hidden risk for investors given assets valued in NZ dollars are only one side of the equation.
For example, on the other side of the ledger, a large chunk of normal living costs are ultimately priced in offshore currencies – most notably, the US dollar – covering items such as petrol, cars, medicine, computer equipment, whiteware and other imported goods.
Even home-grown staples like milk and meat are priced in foreign currency terms, reflecting their status as global commodities with prices set by offshore buyers.
The outsize impact of global currency fluctuations on NZ living costs has come home to roost this year amid the soaring value of the US dollar, which has appreciated almost 9% against the Kiwi over the year-to-date and lies about 11% higher than the same time last year.
In essence, the NZ dollar now buys around 10% less of goods priced in US dollar than it did a year ago including a significant portion of everyday imported consumables like petrol, and locally produced beef and dairy.
While the majority of media attention has been focused on petrol prices and $10 lettuces fuelling NZ’s latest 7.3% inflation rate (a 32-year high), the negative impact of a lower Kiwi dollar on the country’s overall wealth has largely escaped the headlines.
Both sides of the coin: why wealth is local and global
Consider the example of the average balanced KiwiSaver fund, which returned roughly -10% in NZ dollar terms for the last 12 months (many funds performed below this level with a wide spread of returns over this period).
For US investors owning this same average balanced fund, their return would have been more like -21%, accounting for the fact that most of these assets were anchored to the poor-performing Kiwi dollar. Conversely, over the last year, Kiwi investors have experienced just as poor a return (expressed in US dollar terms), but the fact may have passed them by.
Of course, in reality the fundamental return of the fund hasn’t changed but the currency basis has a strong influence on reported performance.
The same logic applies to other parts of the Kiwi economic equation. For instance, if the hypothetical American investor owned a house here while earning a salary in NZ dollars, both income and property values would have depreciated by around 11% over the year as a result of the dip in our currency.
And here’s the rub – the above scenario actually happened: Kiwis got materially poorer over the last year because of the decline in the NZ dollar. However, most New Zealanders are blissfully unaware of their falling wealth because it is typically reported in local dollar terms.
But by assuming the perspective of a US person owning NZ dollar-denominated assets, the scale of the wealth reduction – and the risks of home currency bias – rapidly becomes clear.
Finding the ‘right’ currency exposure for NZ investors, however, also requires viewing both sides of the equation. If the Kiwi dollar is rising, for instance, it’s easy to overlook the fact that our local houses, shares and incomes etc have gone up in value (based on a global view) and focus instead on the shrinking valuations of unhedged global assets in the portfolio.
Clearly, NZ investors can source diversification benefits not just by owning different types of assets but also among foreign currency holdings. On the other hand, those Kiwis with a portfolio skewed to a currency home-bias risk exposure to a loss in overall purchasing power and absolute wealth, relative to the rest of the world.
The recent experience of Sri Lanka, which has seen its rupee lose 43% against the US dollar since March this year alone, serves as a grim example of home-bias risks in portfolio currency weightings.
Kiwis can at least take comfort that the demise in the NZ dollar in recent times has been less catastrophic.
How to beat home-country currency bias
The recent foreign exchange market volatility – and evidence of how it affects overall wealth – should prompt investors to spend time thinking about currency hedging and its potential impact on portfolio performance.
Furthermore, the real-life experience also helps explain the impact that an investment manager’s currency hedging approach can have on a fund’s overall returns (discussed in further detail in a previous article). Within many diversified managed fund options, a few common approaches to currency management include:
- Hedge out all currency risk by investing in global funds that are 100% hedged to NZ dollar;
- Fully hedge their global fixed income, while only hedging 50% of global equity exposures;
- Not hedging their global share exposures; and,
- Active currency management.
In both the second and third options, an investor’s exposure to foreign currency is a function of the size of their allocation to global shares. Accordingly, an investor with a ‘growth’ strategy fund has more exposure to foreign currencies than their ‘conservative’ counterpart. While this convention prevails across the industry, it is odd or ill-conceived from an investment-purist perspective as foreign currency exposure can be justified in an investor’s portfolio irrespective of the level of global equity assets.
Despite the flawed framework, NZ fund managers nevertheless still seem to flock together in setting currency exposures relative to offshore equities holdings due to comfort reasons (in fact most managers, including the base currency settings on peer group averages).
Kiwi investors, though, might benefit by considering a fifth option: a customised hedging arrangement whereby one holds enough currency exposure to match foreign currency denominated liabilities.
Say an investor put everything into a global shares portfolio and estimated about 40% of their wealth is spent on foreign liabilities: under this scenario, a matching portfolio would consist of global equities investments split 60/40 between hedged and unhedged allocations.
Alternatively, it may make sense for Kiwis to dedicate a portion of their investment portfolios to holding foreign currencies direct, particularly as international borders open up again and travellers look for pragmatic and financially prudent ways to manage cash.
Predicting foreign exchange movements is, however, notoriously difficult even for seasoned professionals but the important lessons from the recent foreign currency market volatility for Kiwi investors include:
- Be mindful of bias towards only thinking in NZ dollar terms – query what any headline numbers actually mean in relation to your purchasing power on a world stage;
- Understand the impact that currency movements can have on overall returns; and,
- Consider the appropriate currency hedging strategy to utilise in investments relative to your individual foreign liability exposures.
Putting this all into practice, InvestNow has a wide range of funds and tools to help Kiwi investors implement hedging strategies to suit their individual circumstances, as well as access to expert insights from fund managers and industry players to guide everyday Kiwis closer towards their financial goals.
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