Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 273

The positive FX hedge returns have now gone

Not many investors realise that a decent chunk of their US equities and fixed-income performance over the last 20 years has come from the benefit of hedging, and had nothing to do with the assets' underlying returns.

According to CBA research, hedging your US shares or bonds into Aussie dollars increased your returns by 4% per annum over this period. That is to say, you were paid to hedge, rather than hedging imposing a cost. For lower yielding asset-classes like fixed income, this made a big difference to the realised outcomes.

Between 1999 and 2018, US treasury bonds yielded only 3%, but by hedging into Aussie dollars, the yield increased to 7% while also reducing realised volatility significantly.

Tailwind becomes a headwind

Now the big deal is that this tailwind, which reflected the fact that the RBA’s cash rate was historically situated well above the Fed’s cash rate, has reversed as the Fed has embarked on its hiking cycle.

The chart below shows precisely how this dynamic has changed since 2011. The lower black line is the annualised yield on a US treasury bond while the upper grey line shows the same asset hedged back into Aussie dollars. Observe that in 2011, a US treasury yielding 2.5% morphed into a nearly 7% yield for hedged Aussie investors. The red dotted line represents the benefit or cost from hedging at any point in time.

Click to enlarge

Whereas in 2011 local investors picked-up a return uplift of as much as 4.5% hedging US assets into Aussie dollars, that advantage has fallen away over time to the point now where the red dotted line is slightly negative. In 2018, a 2.94% yielding US treasury paid only 2.86% in Aussie dollars.

Understand the cost or benefit of a hedge

This comes back to the principle known as 'covered interest parity'. If you own a US asset and want to hedge it back into Aussie dollars, the cost will normally reflect the interest rate differential between the two countries for the relevant maturity. For example, if the RBA’s cash rate is above the Fed’s, you should receive additional returns and vice versa.

In practice this relationship can be distorted if there is excess demand or supply for either currency, which can generate a cross-currency 'basis' under which you receive or pay more for the hedge than covered interest parity would otherwise imply.

The Reserve Bank of Australia has been capitalising on this dynamic for years, hedging billions of dollars worth of Japanese government bonds into local currency. While the Japanese bonds have carried a negative yield, hedged into Aussie dollars they deliver a handsome return above many other government bonds because of both the local interest rate differentials and the attractive cross-currency basis the RBA has earned.

It becomes important to recognise this when undertaking long-term performance analysis. I recently saw a presentation for a new, predominantly US high-yield fund that contained historical yields and returns hedged into Aussie dollars over the last five years. The annual yield enhancement from hedging US dollars into our currency over this period was about 1.4%, which is no longer present.

With this benefit the US high yield product outperformed Aussie high yield by 1.3% in total return terms, albeit that US high yield had much higher volatility (4.7% versus 2.8%). But this might not be true going forward as the Fed’s cash rate has risen above the RBA’s equivalent.

Something that appears superficially attractive might be a hedging mirage that has subsequently evaporated. This is, of course, a generalised statement and one should evaluate every investment on its merits on a case-by-case basis and ideally seek the counsel of trusted advisers.

And it is not just about outright returns. Many asset classes, including US high yield, can play a valuable role in portfolios if they are less than perfectly correlated with your existing assets and therefore furnish diversification gains.

 

Christopher Joye is a Portfolio Manager with Coolabah Capital Investments, which invests in fixed income securities including those discussed by this article. This article does not address the individual circumstances of any investor.

 

RELATED ARTICLES

3 reasons the Aussie dollar has not collapsed

Does currency hedging provide an edge?

Is the best value for Australian credit not in Australia?

banner

Most viewed in recent weeks

Simple maths says the AI investment boom ends badly

This AI cycle feels less like a revolution and more like a rerun. Just like fibre in 2000, shale in 2014, and cannabis in 2019, the technology or product is real but the capital cycle will be brutal. Investors beware.

Why we should follow Canada and cut migration

An explosion in low-skilled migration to Australia has depressed wages, killed productivity, and cut rental vacancy rates to near decades-lows. It’s time both sides of politics addressed the issue.

Are LICs licked?

LICs are continuing to struggle with large discounts and frustrated investors are wondering whether it’s worth holding onto them. This explains why the next 6-12 months will be make or break for many LICs.

Australian house price speculators: What were you thinking?

Australian housing’s 50-year boom was driven by falling rates and rising borrowing power — not rent or yield. With those drivers exhausted, future returns must reconcile with economic fundamentals. Are we ready?

Retirement income expectations hit new highs

Younger Australians think they’ll need $100k a year in retirement - nearly double what current retirees spend. Expectations are rising fast, but are they realistic or just another case of lifestyle inflation?

Welcome to Firstlinks Edition 627 with weekend update

This week, I got the news that my mother has dementia. It came shortly after my father received the same diagnosis. This is a meditation on getting old and my regrets in not getting my parents’ affairs in order sooner.

  • 4 September 2025

Latest Updates

Shares

Why the ASX may be more expensive than the US market

On every valuation metric, the US appears significantly more expensive than Australia. However, American companies are also much more profitable than ours, which means the ASX may be more overvalued than most think.

Economy

No one holds the government to account on spending

Government spending is out of control and there's little sign that Labor will curb it. We need enforceable rules on spending and an empowered budget office to ensure governments act responsibly with taxpayers money.

Retirement

Why a traditional retirement may be pushed back 25 years

The idea of stopping work during your sixties is a man-made concept from another age. In a world where many jobs are knowledge based and can be done from anywhere, it may no longer make much sense at all.

Shares

The quiet winners of AI competition

The tech giants are in a money-throwing contest to secure AI supremacy and may fall short of high investor expectations. The companies supplying this arms race could offer a more attractive way to play AI adoption.

Preparing for aged care

Whether for yourself or a family member, it’s never too early to start thinking about aged care. This looks at the best ways to plan ahead, as well as the changes coming to aged care from November 1 this year.

Infrastructure

Renewable energy investment: gloom or boom?

ESG investing has fallen out of favour with many investors, and Trump's anti-green policies haven't helped. Yet, renewables investment is still surging, which could prove a boon for infrastructure companies.

Investing

The enduring wisdom of John Bogle in five quotes

From buying the whole market to controlling emotions, John Bogle’s legendary advice reminds investors that patience, discipline, and low costs are the keys to investment success in any market environment.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.