Is It Time to Currency Hedge Your SMSF Loans Portfolio?
SMSF Loans: As global markets continue to wobble, many of us in Australia, including SMSF trustees and investors, are making hard decisions about how to guard our wealth. One of those decisions relates to hedging foreign investments from movement in currency. Whilst diversification via markets is a reasonable way to diversify, currency movements can often carry a level of influence at least with regards to performance larger than the relatively minuscule impact portfolios can expect from performance to any single market.
For SMSF trustees and members, especially members with offshore property, bonds or equities, it would be worth noting that currency movements influence more than just a short term outcome and do bear some consequence upon long term returns.
So, is it time to hedge your SMSF Loans portfolio? Now let’s take a look.
Understanding Currency Risk in SMSFs
If your self-managed superannuation fund has investments with international assets, we are talking shares in tech companies based in the USA, European mutual funds, or global property trusts that are invested in foreign currencies. At this very moment, currency risk is operating in your portfolio. Currency risk is caused by a movement in the value of the Australian dollar compared to the currencies of the investments you hold.
For example, you might hold a buy in US equities and the US dollar depreciates against the AUD, your AUD returns could decrease even with the stock price rising in local currency terms. This is called currency hedging.
What is Currency Hedging?
Currency hedging is a risk-reducing strategy that allows investors to cap the impact of currency movements. It is accomplished through the use of financial instruments—such as forward contracts, currency swaps, or futures—to lock in exchange rates and safeguard your returns from adverse movements.
For asset purchases and foreign currency-denominated SMSF loans, currency hedging can be particularly useful. While it does not eliminate risk, it keeps volatility in check, yielding more stable outcomes.
Why SMSFs Must Sit Up And Listen Now
The Australian dollar is as unstable as they come. It’s influenced by a host of considerations including differentials in interest rates, commodity prices, and uncertainty around geopolitics. For SMSFs that are heavily exposed to offshore currencies, including through equities or commercial finance to buy real estate in the offshore market, this can be a material risk.
As global interest rates are volatile and global tensions shape market sentiment, it may be an especially prudent time for SMSF lending members to review their currency exposures. A hedging policy can be a safeguard in times of uncertainty, preserving capital and smoothing income flows.
Hedging Strategies for SMSFs
There are a number of methods self managed super fund trustees use to currency hedging. Here are a few of the more popular ones:
- Fully Hedged Approach
Under an outright hedging strategy, exposure of your whole portfolio of international investments to currency movements is zeroed out. This can reduce volatility but can also limit upside potential if the AUD falls.
- Partially Hedged Strategy
A partial hedge is more flexible. As an example, you could hedge 50% of your foreign equity portfolio. This balanced scenario takes advantage of the positive aspects of hedging with the upside potential of beneficial currency movements.
- Dynamic or Tactical Hedging
This strategy involves the adjustment of your hedge ratio based on the market situation, economic indicators, or the predictions of currency movement. It requires ongoing monitoring and is suitable for experienced investors or financially advised persons only.
- Natural Hedging
There are situations when the currency risk can be naturally minimized. For example, if your smsf includes foreign assets and loans in one and the same currency, the risk partially cancels out.
Considerations Before Hedging
Before embarking on a hedging strategy, SMSF trustees must consider the following:
➤ Cost vs. Benefit
Hedging is not inexpensive. It has costs of transaction, management fees, and perhaps margin requirements. Consider whether hedging cost is worth the reduction of risk it presents.
➤ Investment Horizon
Short-term volatility is likely not a concern if your time horizon is 10–20 years. But for funds approaching retirement or anticipating a large withdrawal, hedging will smooth short-run returns.
➤ Asset Type
Some assets—international equities, for example—are more sensitive to currencies than others. Cash equivalents and bonds will be less volatile, requiring less hedging.
➤ Tax Implications
Gains or losses from hedging can have taxation consequences. Ensure you understand how these impact your fund’s taxing point.
➤ Investment Strategy and Trust Deed
Ensure hedging is permitted in your SMSF trust deed and is in accordance with your investment strategy. Document any change in the fund’s investment objectives.
Currency Hedging in the Context of SMSF Lending
For SMSF loans borrowers investing in foreign real assets or infrastructure, hedging is an even greater consideration. If your foreign currency-denominated loan increases in repayments when the AUD depreciates, your cash flows are squeezed or even force assets to be sold.
Hedging offers double benefits in such cases:
- Fixing loan repayment values.
- Protecting investment yields and returns.
Similarly, if you’re investing in foreign commercial loans, hedging can safeguard your interest income against currency devaluation.
Real-Life Scenario
Let’s say that your SMSF invests AUD 500,000 in American shares when the AUD/USD exchange rate is 0.75. That leaves you exposed to USD 375,000. If subsequently, the AUD appreciates to 0.85, your investment in USD is now only AUD 441,000—without any fluctuation in the value of the asset.
A hedging plan could have prevented this loss, demonstrating the advantage of actively managing currency exposure.
SMSF Tools and Services
If you are considering implementing a hedging plan, there are a variety of tools and websites that can help SMSFs do so:
Managed Funds which have Hedging: Several managed funds and ETFs both have hedged and unhedged forms.
Derivatives Platforms: Advanced investors are able to obtain access to forward contracts and options from brokers.
SMSF Loans Specialists: Businesses like Efficient Capital offer SMSF loans expertise in coordination of investment and currency strategy with funding arrangements.
It can be possible to consult a qualified SMSF Loans advisor so that hedging decisions align with compliance needs and long-run financial goals.
Conclusion
In a more globalized and volatile financial landscape, SMSF trustees cannot risk ignoring currency risk. Hedging is an important weapon to offset this uncertainty, potentially protecting the long-term integrity of your retirement savings.
Are you investing in offshore assets, using SMSF loans, or investing in commercial loans offshore? This could be the time to review your exposure to currency and implement a hedging solution that suits your risk profile.
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