Is it time to currency hedge your portfolio?

The US dollar has been making headlines this year as the currency has been caught up in the Trump administration's plans to restructure the global economy.

For many investors with exposure to global equities, fluctuations in currency movements can make a big difference to returns.

For example, the difference between being hedged or unhedged as an Australian investor in U.S. assets over the past 10 years led to a 62% difference in total returns.

As a result, investors should be very eager to understand the implications of changes in value of the greenback.

In recent years, diverging growth and inflation dynamics between Australia and the U.S. have driven the Australian dollar lower, with the AUD resuming a decade-long downtrend in early 2021 and falling to as low as US60 cents.

This decline has significantly amplified the returns of unhedged U.S. assets for Australian investors - underscoring just how critical currency exposure has become.

However, the narrative is shifting and there are early signs of these trends reversing and the USD running out of steam.

Why the AUD could strengthen

Currently, the scope for continued USD strength looks increasingly limited. Positioning in the greenback appears elevated, and on most fundamental currency metrics like purchasing power parity the USD is considered overvalued.

A persistently strong US dollar also conflicts with the trade goals of the Trump administration - namely to reduce the US trade deficit with major trading partners, such as China and Europe, in a bid to revitalise domestic industries and create domestic jobs under an "America First" populist agenda.

Meanwhile, the AUD could receive support if the Chinese government rolls out expansionary stimulus to restore policy credibility and market confidence which may improve risk sentiment and support commodity prices.

These developments could catalyse a dramatic mean reversion in the Aussie dollar which is currently 13% below its long-term average (around US$0.75 to April 30, 2025) at time of writing.

This would have significant impacts on Australian investor returns at a time they are more exposed to the USD than ever.

The case for tactical currency hedging

Most global equities and global equity ETFs held by Australian investors are unhedged.

In addition, self-directed investors tend to hedge significantly less than professionally managed model portfolios or superannuation funds.

This "under hedging" is occurring despite US equities, and by extension the US dollar, now comprising over 70% of developed market benchmarks such as the MSCI World Index, still around the highest levels on record.

With US equities comprising most of the global benchmark, movements in the AUD/USD exchange rate have a major impact on unhedged returns.

Over the past decade, being unhedged has provided a tailwind, but this dynamic can reverse - and there are clear historical precedents for extended AUD strength and relatively poor unhedged US and global equity returns.

Since the Australian dollar was floated in 1983, the AUD/USD has averaged around 0.75, and even in the past decade has touched 0.80 on multiple occasions. If the AUD were to return to 80 US cents, it would reduce the local return on US equities by approximately 20%.

Considering a long-term approach to currency hedging

Notwithstanding the points above, it's worth noting that forecasting the direction, magnitude and timing of currency movements is very hard to get right.

In reality, there are pros and cons to either approach. Based on Betashares analysis of historic data, there could be a case for currency hedging a portion of a portfolio's global equities exposure from a return and volatility perspective.

For Australian investors, leaving a portion of your global equities exposure unhedged can lower portfolio volatility and drawdowns in periods of strong equity market drawdowns.

This is because the AUD is seen as a "risk on" currency, whereas the US dollar is often regarded as "safe haven" currency which historically has tended to appreciate in periods of market sell-offs.

Trend can be a friend, or foe

If remaining unhedged or having a lower level of currency hedging is better from a drawdown and risk standpoint, what about portfolio returns?

Betashares analysis considered the return implications of currency hedging over different 5 year-time frames going back to 1988, where AUD appreciation or depreciation could have had a significant impact on overall outcomes for a hypothetical diversified portfolio.

Historically, the analysis found that being completely unhedged or 100% hedged increased the return outcome uncertainty.

Where the level of currency hedging employed was between 30% - 80%, there was far lower variability between the minimum and maximum 5-year return outcomes.

So, to hedge or not to hedge?

Investors with a view that the AUD is set to appreciate as the USD undergoes a fundamental challenge to its decade long dominance can choose to express a tactical view by increasing the hedged portion of their global equities portfolio.

For those investors not wishing to express a tactical view on the USD, currency hedging a portion of a global equities allocation could reduce the variability of long-term return outcomes making hedging still worthwhile.

As markets embrace more currency volatility under greater geopolitical and policy uncertainty, it is important for individual investors and their advisers to determine the level of currency hedging most suited to their own risk tolerance and objectives.

Review your current hedge ratio and ask: are you prepared for an AUD rebound?

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