International stockmarkets rose by 8.4 per cent last month but the ever-strengthening Australian dollar means superannuation fund members are missing out on the full benefit of the turnaround.
The dollar hit a low of US47.8 cents in April 2001 but fetched US65 cents this week - a 36 per cent increase over the two years. Since the start of the year the Australian dollar has moved almost 15 per cent higher against the US dollar. The local currency has also firmed against other major currencies.
There are many factors determining exchange rates, but the main reason for the rising Australian dollar is the difference in interest rates between Australia and the United States, and between the Australian dollar and other major currencies.
Australia's cash rate of 4.75 per cent compares particularly favourably with the United States' cash rate of 1.25 per cent. Fund managers scour the globe, seeking out the highest returns. They need to buy Australian dollars to invest in Australian securities, and this buying pressure is pushing the value of the Aussie dollar higher.
When the value of the Australian dollar goes up, the value of overseas investments, in terms of the Australian dollar, goes down. Each percentage point rise in its value against the greenback sees a percentage point come off the returns of US-dollar-denominated investments.
Superannuation funds have it within their power to remove the exchange rate risk from their funds - in the form of currency hedging - but on the advice of asset consultants, they generally do not.
Leaving funds unhedged means that any gains in international stockmarkets, such as occurred last month when stockmarkets rose by 8.4 per cent, will not fully flow through to superannuation funds and their investors. For example, the 8.4 per cent April rise translates to a rise of only 5.2 per cent when converted back into Australian dollars.
The currency effect is mitigated because most superannuation fund members are invested in well-diversified funds. The typical superannuation fund has 70 per cent of its assets invested in "growth" assets such as shares and property, and 30 per cent in "income" assets such as fixed interest (bonds) and cash. About 25 per cent of the typical growth fund is invested in international shares (more than half in US shares).
Asset consultants InTech Financial Services says that, for April, these "growth" funds returned, on average, 2.9 per cent - the largest monthly return since October 2001. InTech says the returns would have been 3.4 per cent had superannuation funds had the international shares component of their funds fully hedged for currency. For the year to April 30, the return on growth funds was, on average, minus 6.1 per cent.
According to InTech, had the funds been hedged, they would have returned minus 4.6 per cent. It's alway easy to be wise after the event, however, and the rising Australian dollar is no exception.
It's important for investors to understand that currency movements have impacts - both negative and positive.
Since the floating of the Australian dollar in December 1983 at $US93 cents, its value against the US dollar has decreased by around 40 per cent, boosting Australian's retirement savings substantially.
The big question is whether this long downward trend of the Australian dollar against the US dollar has created a complacent attitude to currency management among superannuation trustees and those asset consultants that advise them.
Asset consultants mostly recommend to superannuation fund trustees they do not hedge for currency (or if so, only minimally) because, they say, changes in the exchange rate are impossible to predict. Also, exposure to currency exchange rates adds an important extra diversification to an investment portfolio. Andrew Korbel, an InTech senior consultant, says currency movements are "uncorrelated to investment markets", meaning they do not move in line with sharemarkets or bond markets. Because of this, over the long term exposure to currency movements actually helps provide comfort to investors by dampening the volatility of returns.
Korbel says those investing for their retirement should not be thinking in the short-term. He points out that most of the rise in the Australian dollar has occurred in just one year. If you're investing for one year, you shouldn't be invested in shares, particularly in international shares - they are just too risky, says Korbel.
"Over the long run, exposure to shares will give investors return enhancement and exposure to currency will reduce the volatility of returns," he says.
A check of the websites of some of the bigger superannuation funds shows they are not providing their currency hedging policies or whether their funds are hedged for currency.
There was probably not much call by investors for such hedging information when being unhedged was boosting returns. Now the Australian dollar's rise is detracting from returns, Korbel thinks investors will start taking an interest in their superannuation funds' currency hedging policies.
Superannuation funds are increasing their exposure to overseas investments. The typical diversified superannuation fund holds about 25 per cent of its assets in international shares - up from 17 per cent five years ago.
For many of the large corporate funds and master trusts, the exposure to international shares is as high as 30 per cent.
There's a further factor to consider. Many superannuation funds are allowing their members to elect to put all of their superannuation money into international shares, leaving the portfolio 100 per cent exposed to movements in the Australian dollar. "The short-term impact on returns, positive and negative, can be extreme," says Korbel. He thinks most investors probably can't live with this volatility and will want to hedge out some of the currency risk.
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