The NZ dollar tends to perform better during periods of optimism and when the global economy is robust, writes Mark Lister.
OPINION
If you buy a US listed share or exchange traded fund (ETF), it’s not just changes in the share price that will determine your return.
You also need to keep an eye
on the exchange rate between the New Zealand dollar and US dollar.
Sometimes the moves between currencies can work in your favour, like this year.
The S&P 500 in the US is up 6.9 per cent in 2024, which is a very healthy return just four months in.
In addition, the NZ dollar has slipped 6.0 per cent against the greenback on the back of resilient US economic indicators and stronger than expected inflation.
When those currency moves are accounted for, the return to a local investor in the S&P 500 jumps to 13.7 per cent.
Declines against the Australian dollar, British pound and the euro have also boosted returns to local investors in overseas markets.
However, this isn’t always the case.
There have been times where currency moves have proved a headwind, or even turned positive returns into negative ones.
Historically, the NZ dollar tends to perform better during periods of optimism and when the global economy is robust.
In the world of currencies, we’re seen as a higher-risk prospect.
Our economy is small and highly dependent on commodity prices, which can be volatile.
When markets get nervous, investors ditch the NZ dollar and flock to the safety of currencies like the US dollar and Japanese yen.
Because of this, rising global sharemarkets generally go hand in hand with a stronger NZ dollar, and vice versa.
At times, this has proved a useful shock absorber, such as during the GFC.
Sharemarkets were down heavily between 2007 and 2009, with the US market falling much harder than the local NZX.
This risk aversion also impacted the NZ dollar, which fell 40 per cent in just 12 months, from US$0.82 in early 2008 to below $0.50 at its GFC nadir in March 2009.
This decline partially offset the slump in share prices, which meant that in NZ dollar terms US shares held up better than local shares.
It was a similar story during the lockdown-induced recession of 2020, with a slumping NZ dollar shielding investors from the brunt of the falls.
In contrast, during the US recessions of 1990 and the early 2000s, currency moves made a difficult situation worse.
During both those periods, the NZ dollar appreciated against the US dollar, sending returns even further into the red.
Over the past 20 years overall, currency moves have added slightly to returns from US shares, but eroded returns from Europe, Japan and the UK.
At US$0.59, the NZ dollar is below its 25-year average of US$0.66, but it’s above its long-term average against other major currencies.
If things revert toward the average over the coming years, your share portfolio will experience some headwinds and tailwinds as a result.
While that’s another moving part to consider in a portfolio, we shouldn’t let it discourage us from investing in great companies from across the world.
Over the long-term, currency moves don’t have a significant impact on returns and at times they can help reduce volatility.
Many local investors are happy to take on some currency risk, and the best way to think about this is to consider it an insurance policy against our small, vulnerable economy.
However, if that worries you or if you dislike the idea of something else to try and predict, hedging the currency is an option.
Professional investors and those with large portfolios often do this, to varying degrees, and there are many funds and ETFs that make it easily achievable.
The exact level of currency hedging to apply across a portfolio is debatable, but somewhere between 20 and 50 per cent is probably about right for many typical investors.
That leaves enough unhedged international exposure to counterbalance an unexpected shock to our economy, or another event that could send the currency lower.
Holding a portion of your wealth outside our shores is crucial for New Zealand investors, and we shouldn’t let the prospect of currency movements dissuade us from taking opportunities in other markets.
Mark Lister is investment director at Craigs Investment Partners. The information in this article is provided for information only, is intended to be general in nature, and does not take into account your financial situation, objectives, goals, or risk tolerance. Before making any investment decision Craigs Investment Partners recommends you contact an investment adviser.
