Imported inflation can be caused by a weakening local currency or an increase in foreign prices.
We all know a weaker Aussie dollar can import inflation by making imported goods and overseas holidays more expensive.
Offshore assets can help protect against these risks. If prices of imported goods are rising overseas, the value of any global investments should increase to offset or hedge against these rising prices.
In addition, an investor protects against the depreciation of their currency because their overseas assets are now worth more to them when converted into Aussie dollar. In this example the strong US dollar will buy more Aussie dollars when converted.
Historically, in falling markets, currency has worked in the favour of Australian investors, because over time there has been a strong relationship between the Aussie dollar and global equity markets.
With a positive correlation over the last 20 years, the Australian dollar is seen as a “risk on” currency. This means it moves with markets, generally weakening when equity markets fall and strengthening when markets rise.
For a local investor this can be a huge benefit. When global equity markets fall, a weakening Aussie dollar will give a boost to the portfolio return on your overseas equities in Aussie dollar terms. The 2008/9 financial crisis illustrates this perfectly.
For an Australian investing in the US during the 2008/9 financial crisis, the Australian domestic market fell -33 per cent and the US market lost -41 per cent, a significant drawdown in their local currencies. However, as the US market fell, the Aussie dollar fell with it. The weaker Aussie dollar (-33 per cent v US dollar) meant that one US dollar of return bought 33 per cent more Aussie dollars. Consequently, the US market in Aussie dollar terms only fell -13 per cent, offering significant benefit to an Australian investor.
In a period of significant stress for many investors the currency has saved a huge 30 per cent of your super. Part of the diversification benefits of investing overseas is actually generated by diversifying your assets away from the Aussie dollar which historically has the tendency to weaken in times of financial market stress.
Of course, investing in global shares presents a range of possible risks for a new investor and every investor’s circumstances are different, so one should always seek professional advice.
Dan Pennell, senior portfolio manager, Plato Investment Management
