Australians tend to cheer when the Australian dollar (AUD) goes up. It’s as if a rising AUD is an international endorsement of the country. However the AUD is not a national scorecard. The impact of a higher or lower currency varies across the economy – and investors’ portfolios.

Understanding these impacts allows investors to strategically adjust their holdings to take into account their investment risk appetite and any view on the currency outlook. This can be an important part of the maximisation of returns and minimisation of risk at a portfolio level.

The RBA prefers a lower AUD, and has done for some time. The minutes from the July meeting released last week re-iterate:

“The depreciation of the exchange rate since 2013 had also assisted the economy in its transition following the mining investment boom. An appreciating exchange rate would complicate this adjustment.”

The fluctuating fortunes of the Australian dollar

The stimulatory impact of a falling AUD is an important factor in any acceleration of the Australian economy. The boost to exports and drag on imports increases both international and domestic competitiveness for Australian producers. The cost is usually potential inflation. However in the current atypical low-inflation environment this effect is welcome.

 A lower AUD is therefore an unambiguous good for the broader economy, and for the overall prospects for the Australian share market.

This does not mean a weaker AUD is positive for all Australian companies. Some are badly hurt by a falling currency.  Importers and companies with significant overseas costs suffer. Retailers such as JB HiFi, Harvey Norman, Myer, Premier Investments and Oroton import many of the brands they sell. The cost of these goods goes up when the AUD falls. Qantas and Virgin are billed for their fuel in US dollars (USD) and pay more when the AUD drops. Similarly Coca Cola Amatil sources much of its ingredients from overseas. The corollary is also true – these companies benefit when the AUD rises.

Some Australian listed enterprises have structural hedges against currency fluctuations. Where they own substantial assets located in a country, they may borrow to approximately match the asset value. This not only hedges the capital exposure, it can mean revenue streams are offset by debt servicing costs, delivering an income hedge as well. Boral’s USD debt is now increasingly serviced by their US building materials businesses.

For some companies hedges arise from the nature of their operations. Mining companies receive USD for the commodities they produce, meaning they win when the AUD falls. However at the same time a rising USD tends to push commodity prices lower, reducing resource company benefits.

Then there are companies that earn income in USD, JPY, CNH and EUR. A sliding AUD makes these earnings more valuable. Companies such as Ansell (ANN), Aristocrat (ARI), Brambles (BXB), CSL, Cochlear (COH), James Hardie (JHX), Treasury Wine Estates (TWE) and Westfield (WFD) all receive a boost from a lower AUD, and are hit when the AUD rises.

The strategic response to an increase in currency volatility depends on the individual. The rise of trading platforms mean that more experienced investors can directly hedge currency risks if they choose. Investors seeking a less active approach may tilt their portfolio toward their risk appetite.

The chart shows the current trend in the AUD against the USD is up. A rising currency works against the broad economy, and the market. Investors concerned this trend will continue could consider shifting towards those retailers and other importers that increase profits in an appreciating AUD environment. The “ballast” of this portfolio may be resource stocks, with their more currency neutral exposures. This is a more defensive tilt.

Investors expecting a drop in the AUD have more choices. They could move away from the defensive tilt, selling down importers. Those with high conviction may rotate into the international earners to increase the benefits of an AUD tumble. Decreasing resource exposures could also increase overall portfolio sensitivity.

There is a strong trend among individual and SMSF investors towards direct purchase of international shares. The skewed nature of the Australian index and the lack of options in sectors such as IT appear to drive this international diversification. However investors should be aware that this increases currency risk. Overseas shares fall in value to Australian investors when the AUD rises, and increase when it falls. Just like most Australian stock portfolios.