Investing overseas can open up exciting opportunities, but it also comes with challenges. One key concern is currency risk – the possibility that exchange rate movements will impact your returns. While international investments can offer potential, fluctuations in currency values can affect how well your investments perform. It’s a factor worth considering as a long-term investor.

This article explores currency risk and how you can manage it to protect your investments. Let's walk through some practical ways to minimise risk and make informed decisions when investing globally.

What is currency risk?

Currency risk is a type of systematic risk . It’s the chance that exchange rate movements will affect the value of your overseas investments. When you invest in assets outside Australia, their value can be tied to foreign currencies. This means that changes in the exchange rate between the Australian dollar and another currency can impact your returns.

But currency risk isn’t always negative. Sometimes, it works in your favour. However, since exchange rates can fluctuate unpredictably, there’s a level of uncertainty involved. These movements may have nothing to do with the actual performance of your investment, which can be frustrating as an investor.

Understanding how currency risk works can help you decide if investing overseas fits with your overall strategy. You might be comfortable with this extra layer of risk, or you may prefer to minimise it.

Why is currency risk an issue when investing overseas?

As mentioned, currency risk can affect your investment returns when exchange rates fluctuate. Why does this matter for investors? Again, the main issue is unpredictability. You might invest in a strong-performing international asset, but a shift in exchange rates can reduce your gains when converting them back to Australian dollars.

Currency risk can also increase the volatility of your portfolio. Even if the underlying investment is stable, exchange rate swings can create more uncertainty. This added volatility might not align with your long-term goals, especially if you prefer steady returns.

Another reason currency risk is important is its potential to impact your purchasing power. If the Australian dollar strengthens, your overseas investments might not buy as much as expected when you bring the money home. On the flip side, if the Australian dollar weakens, your international holdings might seem more valuable, but that’s a risk not everyone is comfortable with.

Understanding how currency movements can affect your portfolio is crucial. While currency risk can bring opportunity, it also adds a layer of complexity. Knowing this allows you to weigh your options and decide what level of exposure to foreign currencies feels right for your investment strategy .

How can I minimise currency risk?

There are several ways to reduce your currency risk exposure while benefiting from overseas investments. Here are a few strategies you can consider:

Diversify across regions

One of the simplest ways to reduce currency risk is by spreading your investments across different countries and currencies. This reduces your reliance on a single currency's performance. If one currency drops, gains in others may balance out the impact. Regional diversification can help manage risk while allowing you to explore different global opportunities. Keep in mind, however, that this may not protect against international monetary crises.

Use currency-hedged investments

Currency-hedged investments can potentially shield you from exchange rate fluctuations. Hedged ETFs, for example, track the performance of foreign assets in Australian dollars. This means you can invest overseas without worrying about currency movements. It’s worth noting that hedged products may have higher fees. For some investors, though, the reduced risk can make it worthwhile. Even so, it's worth noting that currency-hedged investments do expose investors to fluctuations in Australian currency.

Monitor exchange rates

Staying informed about exchange rate trends is another way to manage currency risk. If you’re aware of the broader economic environment, you can make more informed decisions about when to invest or withdraw funds. While it’s hard to predict exact movements, keeping an eye on major shifts can help you adjust your strategy.

Invest in stable currencies

Some investors prefer to focus on countries with more stable currencies. While no currency is immune to fluctuations, investing in regions with strong, steady economies may potentially reduce your exposure to wild swings. Countries like the US or those in the Eurozone tend to have more predictable currency movements, which may appeal to risk-averse investors. But, again, it's almost impossible to consistently predict future currency patterns.

Use forward contracts or options

If you’re comfortable with more advanced strategies, forward contracts or options can help manage currency risk. These financial tools allow you to lock in exchange rates ahead of time, reducing uncertainty. However, these strategies tend to be more complex, and it’s important to fully understand the risks involved before considering them.

Minimising currency risk can involve different approaches, depending on your goals and tolerance for uncertainty. By considering these strategies, you can better protect your portfolio while investing in global markets.

Can I invest in international assets whilst avoiding currency risk altogether?

Completely avoiding currency risk when investing overseas is difficult, but there are ways to reduce it. As we’ve touched on, one option is to invest in currency-hedged products, which aim to remove the impact of exchange rate fluctuations.

Invest in hedged ETFs

Hedged ETFs are designed to protect against changes in currency values. These products track the performance of foreign assets but convert everything back into Australian dollars. By doing this, hedged ETFs neutralise the effect of currency movements on your investment returns.

Limit your direct exposure to foreign currencies

If hedged ETFs aren’t your preference, you can still minimise currency risk by limiting the amount of your portfolio exposed to foreign currencies. You don’t have to avoid international investments altogether but can balance them with Australian assets. By reducing the proportion of overseas investments, you’re also reducing your exposure to currency risk. So you still enjoy the benefits of global diversification but with less uncertainty around currency movements.

Weigh the pros and cons of hedging

It’s important to remember that currency hedging isn’t a one-size-fits-all solution. It helps to weigh the pros and cons to see what sits right with you. Here are the benefits and potential downsides of investing in hedged versus unhedged ETFs:

Hedged ETFs

Potential benefits

Potential downsides

Reduced currency risk: Fluctuations in exchange rates are neutralised, offering potentially more stable returns in Australian dollars. Predictable returns: You’re less exposed to the impact of currency volatility, so your returns are more directly tied to the performance of the underlying assets. Easier to budget for goals: With less currency movement, your investments offer more certainty for financial planning.

Higher fees: Currency hedging can involve additional costs, which can result in higher management fees. Limited potential gains: If the Australian dollar weakens, hedging can limit the gains you would’ve made from the foreign currency appreciation. Tracking accuracy issues: Hedged products may not perfectly track their underlying assets due to the complexities of managing currency movements.

Unhedged ETFs

Potential benefits	Potential downsides
Potential for higher returns: If the Australian dollar weakens, unhedged ETFs allow you to benefit from the appreciation of foreign currencies. Lower fees: Since there’s no hedging involved, unhedged ETFs generally have lower management fees. Simpler structure: These ETFs tend to have more straightforward pricing and performance because they don't need to account for currency management.	Exposure to currency risk: Fluctuations in exchange rates can negatively impact your returns, even if the underlying assets perform well. Greater volatility: Unhedged ETFs can experience higher volatility due to unpredictable currency movements. Uncertainty in long-term planning: Currency risk can add more uncertainty, making it harder to predict returns over the long term.

Key considerations when dealing with currency risk

Here are other factors and strategies to consider when navigating currency risk in your portfolio:

Review your investment timeline

The length of time you plan to invest overseas can affect how much currency risk impacts you. Short-term investors might feel currency fluctuations more intensely, while long-term investors may see the effects even out over time. Keep your timeline in mind when deciding whether to hedge or leave your investments exposed to currency risk. And always remember: regardless of the timeline, fluctuations can always affect you.

Consider your investment goals

When deciding how much currency exposure to take on, it’s important to consider your investment goals and risk tolerance . If you have a lower risk tolerance or shorter-term goals, you might prefer more predictable returns with less currency fluctuation. Tailoring your strategy to fit your personal goals can help you manage currency risk more effectively while staying aligned with your broader financial objectives.

Diversify across asset classes

Diversifying across different types of assets can also potentially help manage risk. By investing in various asset classes, such as shares, bonds, or property, you’re not overly dependent on one asset’s performance or currency movement. This balance can potentially provide stability when some assets or currencies fluctuate.

Speak with a financial professional

If you’re unsure about how much currency risk to take on, a financial adviser can help guide your decisions. While we can’t offer personalised advice, speaking with a professional may give you clarity on how to best manage currency risk in your portfolio based on your situation and goals.

Managing currency risk with confidence

Learning to manage currency risk is an important part of investing overseas. While it can add complexity, there are ways to potentially reduce its impact on your portfolio. Whether you hedge, diversify, or stay informed on global trends, the key is aligning these strategies with your objectives and risk profile. Keep these approaches in mind as you explore international investment opportunities. No single approach works for everyone, but there are ways to manage the risk effectively.

Invest your way!