The Australian dollar has fallen by three per cent in the last two weeks and the ASX200 has dropped by 4.2 per cent over the same period
While there is a whole range of factors driving shares lower – iron ore prices, geopolitical tensions and economic concerns - some of the decline can be attributed to the falling exchange rate.
Wearing my “what if” risk hat; if the Australian dollar corrects and stabilises around 80 cents to the US dollar, what will happen to the ASX200? More importantly, do you have a currency hedge?
One effective hedge is to simply hold US dollars. But with interest rates so low in the US, income will be close to zero.
Bonds issued in US dollars offer an attractive alternative. The world’s largest companies, as well as many mid-sized corporations, issue bonds in US dollars, including many familiar Australian names.
Fortescue Metals is one such company. Fortescue have issued a USD senior unsecured fixed rate bond that ranks behind Fortescue’s secured bank facilities. The bond has eight years until maturity and currently offers a high yield to maturity of 5.64 per cent. For those investors who think interest rates are going to rise in the near term, shorter dated USD bonds could be more appealing. Macquarie and QBE have USD hybrids with an expected maturity of December 2015 and June 2017 paying 1.54 and 4.11 per cent respectively.
Newcrest, which is higher credit quality than Fortescue, has a similar dated bond that offers a lower 5.00 per cent yield to maturity. The better credit quality but lower return provides very good relative value.
There is one other bond that is not issued by an Australian company but considered an attractive asset and that’s by Petrobras. The company is a semi-public Brazilian multinational energy corporation, and is the world’s third largest oil producer and fifth largest oil and gas producer, and second only to ExxonMobil in terms of oil reserves.
All of the bonds listed are fixed rate and the bond prices would likely fall if interest rates rise. The back stop with bonds is that if you hold until maturity you can expect repayment of face value and a positive return on your investment.
If you hold US dollars they could be used to buy the bonds, otherwise you would need to convert Australian dollars into US dollars before you transact. Over the life of the bond, income is paid in regular instalments in US dollars and assuming the company survives, the USD100 face value of the bond is returned at maturity.
Should the Australian dollar fall against the US dollar, and all else remains equal, investors could then sell the bonds, cushioning possible losses elsewhere in the portfolio. Unlike term deposits, bonds are tradeable, can earn higher than expected returns, can add diversity to a portfolio and can hedge currency, higher and lower interest rates and inflation.
Foreign currency bonds take on additional currency risk, over and above the credit quality of the company issuing the bond and are only available to wholesale investors.