The Currency Hedging Decision Is Not Symmetric for Australian Investors

An Australian investor holding global equities holds two exposures: the equities themselves and the currency pair. The decision about whether to hedge the second is usually framed as a choice about reducing volatility, and framed that way it produces the wrong answer for equities.

The Australian dollar is procyclical. It tends to rise when global growth is strong and commodity prices are firm, and to fall when risk appetite deteriorates. This behaviour is well established and follows from the composition of the economy and the currency role as a liquid proxy for global growth expectations.

Why the correlation creates a cushion

Consider a global equity drawdown driven by a risk-off event. Foreign equities fall in their local currencies. Simultaneously the Australian dollar weakens, which raises the Australian dollar value of each unit of foreign currency held. The two effects partially offset, and the loss measured in Australian dollars is smaller than the loss measured in the foreign currency.

Hedging the currency removes this offset. A fully hedged global equity position delivers the local-currency loss in full. The hedge has reduced currency volatility and increased the volatility of the thing the investor actually cares about, which is the Australian dollar value of the portfolio during a drawdown.

Why the answer reverses for bonds

The logic does not carry across asset classes. For foreign bonds, currency volatility is large relative to the volatility of the underlying asset, and it swamps the return the bonds are held to produce. A foreign bond allocation held unhedged is mostly a currency position wearing a bond label, which defeats the purpose of holding defensive assets at all.

The general conclusion is that the hedging decision should be made per asset class rather than as a single portfolio-level policy. Hedge foreign bonds, where currency noise dominates the intended exposure. Consider leaving foreign equities substantially unhedged, where the currency provides a genuine defensive property. A single blanket policy applied to both will be wrong for one of them.

The costs that belong in the calculation

Hedging is not free. It carries the interest rate differential between the currencies, transaction costs, and the operational burden of rolling contracts. When domestic rates sit above foreign rates, the carry can favour the hedged position, and when they sit below it, hedging costs the differential. These are real cash flows that belong in the decision alongside the volatility analysis.

The Rebalancing Problem a Hedge Creates

A currency hedge requires collateral, and a hedge that moves against the holder generates margin calls that must be met in cash. In a period where the Australian dollar rises sharply, a hedged foreign equity position produces hedging losses requiring cash settlement, potentially at a time when the investor would prefer not to liquidate holdings to fund them.

This liquidity dimension is routinely omitted from hedging analysis that focuses only on return volatility. For an investor with limited cash reserves, the operational reality of funding hedge losses can be the binding consideration regardless of what the volatility mathematics recommends, and it is a specific instance of the general principle that a strategy which requires liquidity at unpredictable moments should be sized against the liquidity available rather than against the risk model.