The falling New Zealand dollar highlights the need for KiwiSaver investors to pay closer attention to currency hedging, a fund manager says.
Currency hedging, often utilised by exporters and fund managers in particular, is a tool used to manage the risks from currency exchange rate movements.
The kiwi has fallen by 4 cents against the US dollar in the past month, from US88c to just under US84c, after coming close to breaking its post-float high against the greenback. Before the current decline it had risen by more than US10c (13 per cent) in the space of only 10 months.
And Pathfinder executive director John Berry said the recent swings show KiwiSaver investors should be aware of the effect of the volatile dollar on their investment returns.
Berry said many investors are concerned with fees and returns but don't pay enough attention to currency.
He suggests KiwiSaver members ask their fund manager about their currency hedging policy and how much they are currently hedged, particularly against the US dollar.
"The importance of finding out their hedging is up there with fees and understanding the underlying assets of the fund," he said.
Being fully hedged means if you have an investment in a foreign country the movements in the exchange rate with that country won't affect your return.
An unhedged position exposes you fully to gains or losses from currency movements.
When the kiwi rises against a currency it reduces the value of your investments in that country (in New Zealand dollar terms) and vice versa.
Being partly hedged gives a result between those two extremes.
Pathfinder researched the New Zealand dollar exchange rate with the US since the kiwi floated in 1985 and found hedging can make a significant difference to returns.
"Over a given period, movements in the currency can be bigger than the movements in the underlying assets," Berry said.
The research found being fully hedged gave the biggest returns but the most volatility, while being completely unhedged gave the lowest returns.
This reflected the long-term appreciation of the New Zealand dollar against the US dollar, albeit with considerable volatility, since floating at US44.44c in March 1985.
Pathfinder found a "sweet spot" at 60 per cent hedged, which gave the lowest volatility and returns 2 per cent per year better on average than unhedged portfolios.
And it's not just the NZ/US exchange rate that's volatile, Berry said.
"We recently saw the kiwi rise by 20 per cent against the Aussie in the space of about a year. That stunned a lot of investors who thought our exchange rate with Australia was stable."
ANZ senior foreign exchange strategist Sam Tuck said that in a typical quarter the New Zealand dollar would be expected to move about US2c either side of its average for that quarter.
However, he said these short-term movements weren't much of a concern for investors because managers usually had some degree of hedging.
It was larger, long-term movements in the currency that tended to cause problems, he said.
"Eventually the hedges run out."
- Sunday Star Times