Currency: friend, not foe

Ask most people about currency and you will hear the same word: risky. And in many ways, it is. Exchange rates are volatile, notoriously hard to forecast, and potentially unkind to anyone who tries to pick them with conviction. But inside a diversified investment portfolio, currency plays a very different role. For a small open economy like New Zealand, having exposure to foreign currencies is not just a sensible diversifier, it can be a genuine superpower.

That is not the convention you will hear from every adviser, and it sits uncomfortably with the instinctive desire to "remove the currency risk" especially as this is often the right approach within companies that have offshore earnings. This piece sets out why we think the right question is not whether it is appropriate to have foreign currency exposure within investment portfolios, but rather how much.  Also, we touch on why the answer for a New Zealand investor looks very different to the one that a textbook might give or apply for an Australian investor.

The Kiwi dollar is not the US dollar

There is an old saying that when the United States sneezes, the rest of the world catches a cold. For a small open economy like ours, the impact on the currency tends to be rather more violent than a mild midwinter sniffle, and more like being knocked flat by influenza in the middle of haymaking.

When the appetite for taking risk collapses globally, capital tends to flow out of higher-beta currencies like the New Zealand dollar and into perceived safe havens currencies like the US dollar, the Japanese yen, and the Swiss franc. The NZ dollar often doesn’t just drift lower in these episodes, rather it can drop sharply and quickly. For a Kiwi investor who holds global shares, that fall in the Kiwi dollar is the silver lining: foreign assets denominated in USD, EUR or GBP are suddenly worth more in New Zealand dollar terms, cushioning the equity drawdown.

That cushion is real, it is sizeable, and as we will show, it has shown up reliably in the two biggest market shocks of the past two decades.

The carry that was, and the carry that is not

For many years, New Zealand investors hedging their offshore exposure were paid handsomely to do so. The mechanism is the "carry" or “forward points”. When you hedge a foreign asset back to NZ dollar, you are effectively borrowing the foreign currency and depositing it in NZ dollars. Because historically New Zealand interest rates were higher than those in the US, Europe, Japan and most other places that Kiwis invest, investors who hedged pocketed the differential in short-term interest rates as a tailwind.  Put simply, within currency prices investors were getting paid interest to hedge, albeit invisibly, which is the “carry”.

This tailwind “carry” was generous. From the early 2000’s through to around 2016, the implied yield pick-up from hedging global equities back to NZ dollars comfortably averaged more than 2% per annum, and at the height of the GFC briefly touched 6%. It was a meaningful enough sweetener that some New Zealand fund managers argued the carry alone justified 100% hedging any offshore equities back into NZ dollars.

However, as the graph shows, the picture today is very different. The line above (which is the “carry”) has been below 2% since 2016 and has spent much of the recent past hovering at, or below, zero. This reflects that in recent times our Reserve Bank was cutting cash rates in NZ, while the Federal Reserve was hiking.  Meaning the long-standing premium that compensated New Zealanders for parking their money offshore has been worn away. Hedging back to NZ dollars is no longer a "free lunch" and in some periods like now, has been at a small cost.

That single chart undermines the strongest historical argument for high hedging ratios. If the carry is gone, the case for hedging must stand on its diversification merits alone, and in that case, as it turns out, is weaker than many investors assume.

The downside-protection benefit, in numbers

One theory is that hedging currency risk back to NZ dollars provides downside protection to investors.  However, while theory is one thing, the track record of this is another. We looked at the MSCI ACWI in unhedged NZ dollar terms versus the fully hedged version of the same index, using monthly returns over the past twenty years.

Source: MSCI, Aurellan Asset Management calculations. Returns are total returns in NZD and fully-hedged NZD respectively. Volatility figures are annualised standard deviations of monthly returns over the trailing 5, 10 and 20 years to 31 March 2026. Three episodes do most of the heavy lifting in this argument. During the GFC bear market, holding global equities unhedged saved a New Zealand investor more than sixteen percentage points compared with a fully hedged position (that is 16%!). In October 2008 alone, the worst single month of the crisis, the hedged index fell 16.6%, while the unhedged NZ dollar version fell just 8.1%. The Kiwi dollar did roughly half the work of the equity rally that eventually followed.

The pattern repeated in the March 2020 quarter, when COVID hit markets. The hedged MSCI ACWI lost 20.1% over those three months, while the unhedged NZ dollar version of the same index only lost 10.5%. That is nearly ten percentage points of downside protection delivered by the currency in a single quarter.  This protection arrived precisely when investors needed it most.

And it is not just a "crisis-era" phenomenon. In the most recent down month of our dataset, March 2026, the hedged MSCI ACWI fell 6.6%. Unhedged investors lost 2.4%. The cushion was smaller in absolute terms, consistent with the lower volatility of the Kiwi today, but it was the same direction and the same mechanism.

And the cushion is not just an episodic phenomenon, as it shows up in the long-run volatility figures too. Over the past 10 years, the unhedged NZ dollar version of the MSCI ACWI ran at an annualised volatility of 11.1%, against 13.3% for the fully hedged version. Over 20 years the gap is similar: 12.0% versus 14.0% per annum. On the face of it this is counterintuitive, as adding a second source of risk (the currency) on top of equity risk should make things more volatile, not less. The reason it does not is exactly the mechanism above: because the NZ dollar tends to fall when global equities fall, the unhedged investor gets a partial offset that reduces, rather than amplifies, total portfolio volatility. Currency is doing real work in terms of the diversification benefits it provides, rather than just adding noise.

That said, the cushion is not symmetric across every shock. There are episodes, like the dot-com bust being the obvious example, where the source of the equity weakness is the US itself.  In this situation the US dollar weakens rather than strengthens, and the NZ dollar rises against it. In these windows, historically unhedged investors have experienced more pain, not less. The lower long-run volatility tells you the diversification works on average and across most environments; it does not tell you it works in every environment. Which is exactly why neither extreme is the right answer.

Our liabilities are not all in New Zealand dollars

Step back from the charts and theory for a moment and think about what New Zealanders actually consume and produce. Our biggest export, dairy, is auctioned in US dollars on the Global Dairy Trade platform. The oil and petroleum that moves our country is priced in US dollars. Coal, gas, fertiliser and most globally traded soft commodities are priced and typically settled in US dollars. Imported manufactured goods, electronics and increasingly cloud computing and software-as-a-service are all priced in US dollars, as are even the blue cod that my father caught commercially in the Cook Strait, which is something I have been lamenting since he retired.

Put another way, a meaningful portion of a New Zealand household's real cost of living is fundamentally a US dollar liability dressed up in NZ dollar clothing. When the Kiwi dollar falls, the cost of filling the car, eating blue cod, and buying anything with a microchip in it, goes up. Holding some unhedged foreign currency is not exotic risk-taking; it is a natural offset to a US dollar-denominated cost base most of us already carry without realising it.

Prudent risk management for a small open economy is having your assets in more than one currency. If everything you own, everything you spend and everything you owe sits in the same currency, you have concentration risk, even if the line on the chart looks comforting.

At the risk of sounding like an actuary, not that there is anything wrong with that, in its purest form, successful investing is all about liability matching, such as making sure investors can fund their retirement spending, while charities and foundations can continue to make grants. Therefore, it makes sense that prudent risk management for a small open economy is having your assets in more than one currency. If everything you own, everything you spend and everything you owe sits in the same currency, and your liabilities are driven by another currency, you have a potential problem.

What does the industry actually do?

Ask a New Zealand fund manager what hedge ratio they run for global equities and the modal answer is around 50%. The BNZ FX Hedging Survey, which we think is the most comprehensive look at industry practice, found exactly that.  It shows on average there is a 50% hedging ratio for international shares across KiwiSaver providers, superannuation schemes and fund managers. That is not a coincidence, nor is it laziness. Fifty per cent is the "point of least regret": the position you can live with regardless of which direction the currency moves, and the one that has historically delivered the highest risk-adjusted return for a New Zealand investor in global equities.

Across the Tasman and the answer is very different. APRA data shows that Australian superannuation funds, on average, hedge only around 22% of their international equity exposure, meaning that roughly three-quarters of it sits unhedged. And it is not because Australians have less offshore exposure within their portfolios to worry about. If anything, the opposite is true. Australian super funds now hold more than 50% of their total assets offshore for the first time in the sector's history, with international shares typically a larger allocation than domestic shares. So, the gap with New Zealand is entirely a question of hedging policy, not equity allocation.

Why such different answers to the same question?

At first glance this divergence is puzzling. The Australian and New Zealand dollars are about the most closely correlated pair of currencies in the G10.  Daily moves in our currencies typically correlate above 0.85, reflecting both are commodity-linked, both are smaller/higher-beta currencies, and both fall against the US dollar in genuine risk-off episodes. If the structural story were just "small open economy with a risk-on currency", you would expect Kiwi and Aussie investors to land in roughly the same place. They do not. So, what is driving the gap?

At Aurellan we think there are several things, which are all real, but none individually decisive. Firstly, the Australian dollar has historically been the cleaner version of this trade. It is a much more liquid currency, sits closer to the centre of global foreign exchange markets, and has had a longer and stronger inverse relationship with global equity drawdowns. Australian funds have been able to get most of their downside protection from leaving US dollar assets unhedged, with less need for an active overlay. The Kiwi has been a noisier proxy for the same trade, which arguably justifies a more deliberate hedge structure - rather than relying on the currency to do all the work.

Secondly, the carry economics have run in opposite directions. For most of the past decade, hedging Australian dollars has not offered Australian investors with a meaningful interest rate pickup (“carry”). This reflects that in lots of periods the Reserve Bank of Australia has run their cash rates below the US Federal Reserve, meaning that hedging has resulted in a small negative drag or “carry”. The structural argument for hedging Australian-side was therefore weaker than it was in New Zealand during the long high-NZ-interest rates period. Now that New Zealand's “carry” has also disappeared, that gap has narrowed, but a couple of decades of muscle memory does not simply unwind in two years.

Thirdly, scale matters. With a A$3.7 trillion sector in Australia, the operational cost, collateral management and counterparty drag of running large FX hedge books is non-trivial.  This is reflected by the fact that the Australian regulator has been increasingly attentive to liquidity stress under sharp Australian dollar moves, but a lot of the institutional preference for low hedging is simply that it is cheaper and simpler not to. The New Zealand industry, smaller and with more vanilla balance sheets, has historically accepted that cost.

Fourth, the underlying liability structure is different. Australia is a much larger and more vertically integrated commodity exporter, with these including iron ore, LNG, coal with most of those revenues invoiced in US dollars. A meaningful share of corporate Australia is effectively long the US dollar already. Households are less directly US dollar-exposed than the corporate sector, and the franking credit regime plus a deep, broadly diversified domestic equity market reduce the need to look offshore in the first place. New Zealand sits in a different spot: a smaller, more import-dependent economy where the household US dollar liability (fuel, dairy, imported goods, software-as-a-service) is the dominant exposure, and where the domestic equity market is too concentrated and too small to anchor a diversified portfolio.

And fifth, honestly, there is a degree of institutional convention within the industry. The "point of least regret" at 50% has become the default starting point for the New Zealand industry, while in Australia, the equivalent industry accepted reference point sits well below that. Once these types of defaults are set, they take years to move, even when the case for change is good. Recent CommBank and Deutsche Bank surveys suggest Australian hedge ratios are now creeping higher as funds reassess the historical Australian dollar equity correlations post-COVID.  This means the direction of travel is closing the gap, slowly.

None of this is to say our Australian counterparts are wrong, or that New Zealand should converge to Australian practice. It is to say that the right hedge ratio depends on the structural specifics of where you sit, the depth and concentration of your home market, the FX liability profile of your real economy, the behaviour of your currency in tail events and that for a New Zealand investor those specifics still point to a meaningful, but not dominant, level of foreign currency exposure.

So how much, then?

For a New Zealand investor, neither extreme is obviously right. Zero hedging exposes you to the full force of NZ dollar appreciation in calm periods. Hedging your portfolio 100% to New Zealand dollars strips out the downside cushion just when you most need it, locks in volatility in the wrong direction, and now that the interest rate “carry” has gone, no longer compensates you for the privilege.

For portfolios with a particularly low tolerance for negative returns, like charities and endowments needing to fund regular spending needs, retirees in pension phase, or anyone for whom a 20% capital loss is a behavioural or operational problem rather than a market-cycle annoyance, there is a strong case can be made for running with a very low hedge ratio, or even none at all. The unhedged NZ dollar investor has historically suffered shallower drawdowns in the worst quarters, and for an investor who genuinely cannot ride out the bottom, that protection is worth more than the smoother returns a hedged portfolio delivers in calmer years. It is not the default, but it is a coherent answer for the right kind of portfolio. There are also investors with large swathes of assets exposed to the NZ economy who might benefit from more foreign currency exposure.

All of this is to say that the industry convention of hedging to a level of global shares exposure, is perhaps less important than targeting a specific amount of foreign currency exposure at a portfolio level.

Our view

Currency is volatile, currency is hard to forecast, and currency is genuinely risky if it is the only thing you own. But foreign currency exposure inside a diversified portfolio is something different. It is the closest thing a New Zealand investor has to a free downside hedge, even allowing for the erosion of the carry that historically rewarded New Zealanders for hedging back to a higher-rate currency. The data through the three biggest episodes of equity weakness of the past two decades — the GFC, COVID, and the March 2026 sell-off — supports the conclusion that unhedged offshore exposure has reliably softened the blow when global markets have fallen hardest, while also delivering lower long-run volatility.

The irony is that, despite foreign currency being a superpower for a New Zealand investor, it is one often used sparingly. Why? Perhaps memories of the carry from years gone by anchor us to higher hedging than the current environment justifies. Or perhaps it is the convention of setting hedge ratios at a global-shares-sector level rather than a portfolio level. Take the average KiwiSaver Conservative Fund, with around 12% in global shares, versus the average Growth Fund at 52%. Does it really make sense for both to hedge 50% of those global equities? The Conservative investor still has USD liabilities but a very limited appetite for drawdowns, and we believe little or even zero hedging may be better aligned to their objectives than the industry-standard 50%.

Putting tactical considerations aside, a healthy degree of foreign currency exposure in a New Zealand denominated portfolio rests on structural diversification of currency risk. Unhedged exposures provide offsets to a fundamentally USD-denominated cost of living. The empirical evidence indicates it also provided downside protection through three of the worst equity drawdowns of the past quarter-century, while delivering lower volatility. The principle is the same one we started with, being that currency exposure when used carefully provides a key diversification benefit within New Zealander’s portfolios, not a bug.