Ann: ANZ Wealth Management updated financial information, page-37

I would argue that the hedge against a US equity price fall is partly or wholly unnecessary because the same global disruption scenario that could cause a substantial fall in US equities would probably also cause the AUD to fall against the USD.

@IndexInvestor

Thanks for your post, there is some truth in what you’re saying. Namely:

1) The AUDUSD exchange rate does tend to exhibit positive correlation with US Equity Indexes in the short term, and

2) As a consequence of the previous point, one could be tempted to argue that a hedge against falling US Equity prices is only needed (from an Australian investor’s perspective) to the extent that the exchange rate does not naturally compensate for the price drop in USD equivalents.

But, if you look at the broader historical context, you will realise that the current bull market in US Equities, which started in earnest at the beginning of 2013, has largely run its course in a strengthening USD environment (which contradicts the standard positive Equity/FX correlation argument).

In numbers, the AUDUSD FX rate started 2013 at 1.0424 and is currently at 0.7568, while the S&P500 started at 1,493 and is now at 2,735. Therefore, the S&P 500 has gone up by +83% while the AUD has depreciated by -27%; not too bad as far as (supposedly) positive Equity/FX correlation goes, huh?

In particular it follows that, in AUD equivalents, the S&P500 has appreciated by an astonishing +152% over the period.

Of course it can be argued that the AUDUSD FX rate had to absorb the fallout from the mining boom, the collapse in commodity prices, etc. But, as we speak, commodity prices have entered a phase of reflation, and yet the exchange rate is not too far from its post-GFC lows, in the grand scheme of things.

Therefore, there is arguably a lot less room now, for the exchange rate to compensate for a fall in US Equity prices, than it was the case in the past.

To conclude, while I agree that currency movements might provide IOOF with some cushion in the event of a sharp fall in US Equity prices, I do still see a strong rationale for hedging the International Equity component of FUMAS, when it comes to optimising the risk/reward profile of an investment in IOOF [*]; or, in other words, I no longer see the positive Equity/FX correlation argument as being strong enough to undermine the case for hedging, given the relative valuation of US Equity markets on a currency-adjusted basis.

This too is just my personal opinion, of course. Cheers.

[*]: If you read through the Risk Management section of the Notes to IOOF’s Annual Reports, there is nothing suggesting that the Company does anything to hedge the foreign currency exposures originating from the non-AUD-denominated components of FUMAS.