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Offshore returns fall as dollar moves towards US65c mark

THE unexpected strength of the Australian dollar has been bad news for investors in international shares and the prospect is for more of the same.

The dollar has risen by about 14 per cent this year, to a recent high of US57.9 cents, and most economists are tipping it will reach US65 cents during 2003.

International share markets have been battered by negative returns over the past two years and the rising dollar makes returns even worse for Australian investors.

The impact of the stronger currency on investment returns is monitored by consulting group Intech, which tracks the MSCI World ex-Australia Index, a measure of all major share markets worldwide.

In local currency terms, the index was down 12.4 per cent for the year to May. That’s bad enough, but after converting those returns into Australian dollars, the index was down 19.2 per cent.

Looking ahead, HSBC senior economist Grant Fitzner expects the dollar will be valued at US63 cents by the end of 2003.

Westpac economist Bill Evans

is more optimistic, tipping it

will eventually reach US65 cents

in the second half of 2003.

One of the key drivers of the dollar is the widening interest rate differential between Australia and the United States.

Official interest rates in Australia have already risen from 4.25 per cent to 4.75 per cent, and most economists expect rates will rise to about 6.0 per cent next year.

In contrast, the US’s Fed funds rate remains at a 40-year low of 1.75 per cent and HSBC expects it will stay there for the rest of the year.

In simple terms, this means investors can get a much better return in Australia than in the US.

Another driver of the currency is the prospect of global economic recovery, which boosts commodity prices and Australia’s export prospects.

Exchange rate movements also need to be understood in terms of what is happening in the US, in particular the protracted share market weakness and the large trade deficit.

“We are now witnessing what might be the deflation of the US dollar bubble,” Mr Evans said.

Investment managers can reduce the impact of currency movements by hedging their foreign exchange exposure.

However, Mr Fitzner said many investment managers failed to fully disclose their hedging strategies, leaving investors in the dark as to their currency exposure.

A notable exception is Platinum Asset Management (see article below). It releases regular reports showing its physical market exposure and its currency exposure.

Currency movements do not just affect returns from international shares.

They also have a direct bearing on Australian companies with a large portion of their business based overseas. Examples include Brambles, News Corp and National Australia Bank.

Australian exporters, such as mining companies, are also ad-versely affected by a strengthening currency.

Mr Fitzner said the currency impact would be partly offset by the prospect of higher commodity prices, which should help mining companies maintain earnings.

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