Welcome to the July 2022 Manager Panel! The Manager Panel is where we ask fund managers some questions surrounding a topic. This month we asked Macquarie Asset Management about the impact foreign currency can have on investing. Check out the questions and answers below.

Q1: Within Macquarie Asset Management’s diversified funds, what is Macquarie Asset Management’s approach to foreign currency and hedging?

Foreign currency has an important role to play in a diversified portfolio. Within Macquarie’s diversified funds, the level of foreign currency exposure is a factor that is considered in building a well-diversified portfolio. From this viewpoint, foreign currency can be considered a separate asset class.

The level of foreign currency exposure is primarily driven by a risk management perspective, where the focus is on reducing the level of a portfolio’s downside risk. Foreign currency can play a role in reducing a diversified fund’s volatility. This was most evident during the global financial crisis where the weakness in the New Zealand dollar helped offset losses in global equities. It has also been the case over the six-months period to 30 June 2022, as global equities unhedged outperformed currency hedged by 8.7%.

A reduction in portfolio volatility is important in generating longer-term capital accumulation.

The currency hedging approach is a trade-off between risk management, return outcomes from hedging (including forward points) and ensuring the appropriate implementation of the underlying asset class strategy.

Therefore, Macquarie fully currency hedges those underlying strategies where currency movements would likely undermine the desired investment strategy contribution to the diversified fund, for example global bonds and absolute return strategies are fully hedged. Currency hedging ratios for other asset classes can vary, for example emerging markets are unhedged and global listed property tends to 100% hedged.

Q2: How reactive should long-term diversified investors be to short-term volatilities in foreign currency markets – has the recent volatility caused your own investment team to review or adapt its approach to currency hedging?

Longer-term diversified investors should react to short-term volatilities in foreign currency markets, or any market, by falling back onto their investment philosophies and disciplined investment approach.

At Macquarie New Zealand, for example, we set longer-term strategic asset allocations (SAA) for our clients, including the level of foreign currency exposures, and then run a dynamic asset allocation (DAA) process. The DAA process takes into consideration the economic environment, market valuations and sentiment factors. Any deviations from the SAA are taken with a medium-term view and considering the Fund’s investment objectives.

The recent New Zealand dollar volatility has not caused us to review or change our approach to currency hedging. Despite the recent fall in the New Zealand dollar, we remain comfortable with the Fund’s foreign currency exposures given the deteriorating domestic and global economic outlook.

Q3: With New Zealanders increasingly transacting in foreign currencies, is it possible for Kiwis to be too exposed or biased towards the NZD – and if so, to what degree should Kiwis be thinking about their wealth from a global perspective?

In my mind, New Zealanders should not be over-exposed to the New Zealand dollar and most investors should maintain a level of foreign currency and foreign asset exposure. The level of foreign currency exposure is based on the individual’s own set of circumstances and objectives.

One way of looking at this question, and to help provide some context for having global exposures, is from an asset-liability matching framework. If an individual undertakes regular foreign asset purchases (for example, buying books on amazon and regular overseas trips, which are foreign asset ‘liabilities’) they could consider holding these foreign currencies within their investment portfolio. From this angle, they would have an ‘asset’ that would help offset the impact of movements in currency on their overseas purchases (liabilities).

In summary, New Zealanders should maintain a well-diversified portfolio of assets that is reflective of their individual circumstances and investment objectives.