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Paradigm Group Investment Views: The Benefits of Global Diversification and Active Currency Hedging

International shares play a pivotal role in investment portfolio construction. There are hundreds of international share funds available to Australian investors. It is the role of the Paradigm Investment Committee to draw upon all the resources it has available to narrow this field down to a handful of funds, of the highest quality, to structure the optimum combination to make up the Paradigm International Share Portfolio.

The Portfolio currently consists of the Magellan Global Fund, the Walter Scott Global Equity Fund, the WCM Global Growth Fund, and two Vanguard Funds.

The Paradigm International Share portfolio provides investors with exposure to a spread of truly global enterprises. To name just a few, companies such as Microsoft, Apple, Amazon, Alibaba, Alphabet (Google), Visa, Nestle, are major underlying holdings.

It is important to ensure that the funds selected blend well together, and that they exhibit some variation in the way they are managed, the investment philosophies adopted, and the underlying companies to which they are exposed. Such variation ensures risk is mitigated over economic cycles where certain management styles may provide better performance outcomes than others.

Diversification into International shares has made a substantial difference to portfolio returns over the last few years in particular, as sectors such as Internet and eCommerce, and Information Technology (IT) have exploded  and the share prices of high quality companies in these growth sectors have risen strongly.

By way of example, the Paradigm International Share Portfolio has exposure of approximately 25% to the Internet and eCommerce, and IT sectors, as compared to the Australian index, the ASX 300 (represents the largest 300 companies by market capitalisation) which only has exposure of approximately 3% to these sectors.

 

International Shares v Australian Shares

The following table shows the performance of the Paradigm International Share Portfolio against the ASX 300.

Performance Comparison to 30 April 2020 3 months 6 months 1 Year 3 Years (p/a)
Paradigm International Share Portfolio  -5.4% 3.0% 7.7% 12.7%
ASX 300 Accumulation Index -20.4% -15.6% -9.1% 2.0%

 

The numbers speak for themselves. The performance of the Paradigm International Share Portfolio has exceeded the return of the ASX 300 Index by over 10% per annum over the last 3 years.

It is not only the selection of funds that can add to performance, but also decisions concerning how currency exposure is addressed.

 

Hedged v Unhedged

When an investment is made in an Unhedged Global Share Fund, the investment is exposed to currency movements.

This can be both a positive and a negative depending on the specific movements of the related currencies. All other things being equal, when the Australia Dollars (AUD) falls, as a consequence, the value of the investments held overseas rises. If the AUD rises, the opposite is the case, and losses from the currency exposure result.

So, the best financial outcome is to expose a global share portfolio to currency movements when the AUD is falling (UNHEDGED), but then to negate any negative consequence when the AUD is rising (HEDGED).

The table below shows the significant difference that currency can make to performance. The MSCI World Index (MSCI) is a broad global equity index that represents equity performance across global share markets.

You can see the significant difference in performance of the MSCI Hedged against the MSCI Unhedged, with the benefit of being Unhedged equating to an additional return of 5.4% per annum over the last 3 years (a period where the AUD fell from US$0.76 TO US$0.64).

Performance Comparison to 30 April 2020 3 months 6 months 1 Year 3 Years (p/a)
MSCI (World Index) UNHEDGED -9.6% -2.1% 3.5% 9.9%
MSCI (World Index) HEDGED -12.8% -8.4% -5.8% 4.5%
Paradigm International Share Portfolio  -5.4% 3.0% 7.7% 12.7%

 

Forecasting currency movements in practical terms is very hard to do as currency markets do exhibit considerable volatility and move in response to many economic factors and events.

For many years now, the Paradigm Investment Committee, has been content to maintain all the investments in the Paradigm International Share portfolio as UNHEDGED thus benefiting from the gradual decline in the value of the AUD over the period.

HOWEVER, when the AUD fell towards $0.60, and slightly below briefly, the Committee considered that it was appropriate to effectively lock in some of those currency gains. To do this, the investments in both Vanguard and Magellan were switched to HEDGED.

So far this has worked successfully, as the AUD has moved higher since this action was undertaken.

We will retain the current mix and continue to monitor the AUD’s movements. The current view is that the AUD can continue to strengthen in response to the safe haven nature of Australia resulting from the containment of the coronavirus, and exposure to an improving Chinese economy.

 

Where to from here?

The global economy remains a major concern, and there is a high level of uncertainty over the pace and scale of economy recovery post the coronavirus. Recovery will be supported by regulatory authorities through stimulatory policies, although company earnings must recover to meet the markets expectations.

We continue to be cautious in light of the possibility of a second wave of infection, and future economic instability as a consequence.   Although we do note that recently there has been some positive results from covid-19 vaccine trials and we will continue to monitor these developments.  We are comfortable in the long term with exposure to sectors such as eCommerce and Information Technology and Healthcare, which make up a material portfolio of the current international portfolio holdings.

Please feel free to contact your Paradigm Group advisor should you wish to discuss any issues in relation to your specific circumstances.

 

 

Mike Hawkins, Paradigm Group – Investment Committee Chair

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