The Australian Market in AUD and USD
We know what happened with the Australian All Ordinaries from 2007 to 1 June 2010.
At the bottom of the Australian Stock Market in March 2009 the MSCI Barra index was off 53% in AUD terms from 30 October 2007.
In USD terms it was off about 77%!
The recovery in the MSCI Barra index for Australia from the 9 March 2009 bottom to 12 April 2010 was 58%!
In USD terms it was up 132%
These differences are because the AUD/USD Exchange rate was also changing over the same period. Chart courtesy of Incredible Charts free charting software.
So now we can look at the Australian Stock Market in each of AUD and USD using MSCI Barra.
The numbers above illustrate the difference that movements in the currency can have on investment returns.
Currency and Switching Asset Classes
I am now going to use the perfect example to make a point, but nobody could possibly have achieved the result so don’t think that the actual return is even remotely possible. (I will ignore dividends and interest – at 4% pa they have little effect over the time period we are considering and partially offset one another, even after tax and compounding effect.)
An Australian investor who switched from the All Ords to USD cash deposit on 30 October and then switched back to the All Ords on 9 March 2009 and then switched back to USD cash on 14 April would have :
At end October 2007 for AUD100 he would have got USD 93
At 9 March 2009 for USD93 he would have got AUD 1.56 for each USD or AUD145
As at April 14 2010 that AUD145 in the Australian Stock market since 9 March 2009 would be worth AUD229
On 14 April that AUD 229 would buy USD212 at 0.93
Today the USD212 is worth AUD256
An investor with AUD 100 in the All Ords on 30 October 2007 who has just held his investment now has AUD65
The perfect switching strategy to USD cash and back twice would give you 3.9 times as much AUD now as a mere buy and hold strategy! (But remember I said this was totally theoretical and unachievable in practice.)
There could have been additional profit if our hypothetical switching investor had moved to US 10 year bonds instead of cash. As the interest rates on US 10 year Treasury notes went lower during 2008/09 (see chart of $TNX below from StockCharts.com) the price of 10 year bonds bought in October 2007 would have increased. As rates increased in 2009/10 the price would have fallen back but as rates are still lower the price would still be higher than October 2007.
Of course it works the other way too. A US investor who held his Australian All Ords at US93 (AUD100 equivalent) on 30 October 2007, sold at the bottom on 9 March 2009 and took his funds back into USD and switched to cash would have only USD21 (AUD23 ) on 14 April 2009, compared to the Australian investor who did nothing with AUD65 – about 3 times as much as the US investor.
So the point is, if the AUD is has had large price increases compared to most currencies, maybe switching, or increasing your exposure, to those other currencies for part of your investment might make sense (and vice versa).
Similarly, if the stock market (or any other asset class) has grown very quickly for a long time, switching to, or increasing your exposure to, non-correlated assets that are at lower prices might save a significant fall in investment value if the one which has risen starts to fall.
Diversification to Non-Correlated Assets
Now imagine if our Australian Investor had 50% in USD cash and 50% in AUD shares.
At the peak he had AUD50 in shares and AUD50 (USD46.5) in cash. At the bottom of the AUD market he would have AUD23 in AUD Shares and AUD72.54 in USD Cash of USD46.5. His AUD100 is down to only AUD95.5 instead of being down to AUD47 as it would be in shares. The diversification into non-correlated asset classes has dramatically reduced the unrealised loss as at 9 March 2010.
At 14 April the position is AUD 32.5 in Shares and the USD46.5 is worth AUD50 again (by absolute coincidence of the exchange rates at 1 AUD = 0.93USD on both 30 October 2007 and 14 April 2010). Total value AUD 82.5. On this occasion the diversified investor is in front of the AUD shares only investor, but the generally expected result is that the diversified investor will have sacrificed some earnings but will have reduced volatility as shown above by the much lower fall in value of investment.
Conclusion
This is not a suggestion to trade, but is an introduction to three concepts:
1. Foreign currency exposure can be a good thing.
2. Considering rebalancing strategic asset allocation from time to time might be worthwhile. (called Active or Tactical Asset Allocation – these terms mean different things to different people. I am talking about 4 times a year style approach, not necessarily exactly quarterly, maybe at times of crisis in some country or region, or after a fall in stock markets in a region of more than say, 8%.)
3. Having a portfolio of non correlated assets (like USD bonds and AUD stocks) can reduce the volatility in the value of your investment and help you sleep nights.
Next Post
My next post will be on portfolio construction, risk aversion, volatility and diversification.
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