POC:

Welcome all to another installment of the Netwealth Portfolio Construction podcast series. For those listeners that are new to the podcast series, I'm Paul O'Connor and my role at Netwealth is as head of investments, which includes responsibility for the funds available on our investment menu and the products we issue as a responsible entity. The aim of the podcast is to provide listeners with insights into portfolio construction and strategies that may be appropriate to your client's portfolios. On today's podcast, we have Thomas Al, or Tom, the managing director and portfolio manager from Rochford Capital, and we'll discuss Australian dollar hedging options to hedge Australian dollar exposure in portfolios and Rochford's solution. Rochford provide treasury and market risk solutions to large or listed companies and institutional clients by advising in managing foreign exchange interest rate and commodity risks. And on average, advise on circuit 20 billion in gross over the market transactions for its clients annually.

Rochford works with a broad cross section of corporates and has many years of extensive experience in structuring and negotiating hedging solutions with financial institutions. Hence, they're considered highly experienced in currency overlay solutions and foreign exchange advisory services. Tom is an economist by degree with numerous qualifications in foreign exchange, treasury and derivatives. Before co-founding Rochford, Tom spent eight years at HIF FX originally in the UK before arriving in Sydney in early 2007 to launch HIX FX advisory business to the Australian marketplace. Tom has extensive experience advising some of the largest companies in Europe and Australasia on treasury risk management. The Netwealth IDPS investment menu includes the Rochford for leverage long Australian dollar fund, which is currently only available to wholesale investors and some managed accounts. The investment objective of the fund is to provide investors with a geared exposure to a depreciation in the US dollar, relative to the Australian dollar.

The fund seeks to provide investors with up to three times leverage capital return on the performance of the A-U-D-U-S-D exchange rate. The Rochford for leverage long a UD fund seeks to provide a low cost entry point to a beta exposure to the A-U-D-U-S-D exchange rate on a daily basis and hence is not actively managed. So essentially it's trying to provide a reliable hedging solution rather than attempting to generate any alpha out of currency trading. Given the increasing sophistication of clients managing diversified portfolios using netwealth's platform functionality, the Rochford fund stands out as a possible currency hedging solution for those wishing to hedge all or part of their US dollar portfolio exposure. Finding solutions to hedge US dollar exposure can be a challenge given most diversified portfolios will typically have a strategic allocation to a UD hedged and unhedged offshore assets and over 50% of the offshore assets are typically US domiciled.

This is where an allocation to the Rochford fund could assist in managing the currency exposure as opposed to buying and selling units in a hedged and unhedged international equities fund. From a portfolio management perspective, the A UD is one of the most volatile currencies globally due to it being viewed as by many as a proxy for global growth. What I mean by this is when global growth is strong, the demand for Australian commodities places upward pressure on a UD pricing and vice versa. The outcome from this is that in the last 15 years, the a UD has traded between about US 50 cents and US a dollar 10. So this volatility can materially impact on a portfolio's return. In addition, with the A-U-D-U-S-D currently at about 64 cents, this would be viewed by many as at the lower end of the trading range and as when some diversified portfolios would consider increasing their A UD hedge exposure.

Economists have long debated the true value of the Aussie compared to the US dollar, but using academic measures such as purchasing power parity or interest rate parity, many view the A-U-D-U-S-D fair value at around 75 cents. Of course, projecting currency values accurately is close to impossible, which is why many diversified portfolios set a strategic currency hedge exposure over their portfolios and don't attempt to actively manage. But I'll be interested in hearing Tom's views on the challenges of active currency management. Maybe Tom, for starters, can you provide a few comments on your career journey and how you ended up specializing in treasury and managing market risk and even founding Rochford?

Thomas Averill:

Yeah, absolutely, and thank you for that kind introduction and the opportunity to be here today. Yeah, career highlights so far. I actually started in investment banking and corporate finance after qualifying as economist to be honest, although that was good fun. I joined it, it was too micro for me and there was a requirement to be an accountant which didn't really float my boat and wanted to get back into the macro space, which ended up me in fx, which is FX interest rate markets being the best markets to apply economic views or macro ideals on things. HR FX transferred me to Australian 2007 to launch their advisory business here, HR fx, which is now known as XE incidentally, which is probably a more recognizable plan to your listeners rather. HR FX bought XE with a focus really to become more of a retail focused payments business and my ambition for the advisory business was to become top end of town institutional looking after asset managers, private equity, big corporates.

So there was kind of a divergence in views on the direction of travel there, which resulted in us doing the MBO in 2010 and forming and that becoming not just a currency business for broad macro risks and treasury issues. As you said, we look over after 20 billion across Australian corporates, but also a lot of asset managers including pe, real estate equities, all different types of asset classes. So we're well positioned to understand how currency risk plays in overall portfolio returns and risk diversification, all the other things that are important in the way you construct your portfolios. Tell you one thing, what was interesting from your introduction there, talking about a dollar 10 just considering the news flow that we've had through the weekend, I don't know if you recall what the news fold was when I was a US hit a dollar 10, but it was the last time that the US had a credits downgrade and given that Moody's has dropped its AAA rating through the weekend, I think that's kind of a topical point to highlight.

POC:

I remember it well sort of post the GFC when the Aussie hit about a dollar 10 and the buying opportunity in offshore goods is a great time for Australian consumers there, including myself, but we're a little bit more moderated now at 64 cents there. Well,

Thomas Averill:

Absolutely. I was giving a presentation to a group of treasurers last week and said, look, the dedo of the global economy is a real thing and us credit risk is a real thing, but it's going to take some time, but you can tell your kids take Disneyland in 27 because yeah, I think you're going to see a material weakness in the dollar from here.

POC:

In terms of questions for today, first one, can you provide a few comments on how you see institutional investors managing currency risk in their portfolios?

Thomas Averill:

Yeah, absolutely. I think this is the biggest and most stark thing to draw your listeners where to is actually how currency risk is managed depending on the underlying asset class and expected volatility return profile that you are looking to manage the risk on. So for example, if you've got an income asset that's not going to provide a huge amount of capital return, typically you're going to see institutional investors carrying a high degree of hedging against those type of investments. So fixed income, private credit because currency risk can completely wipe out the income and have obviously detrimental impact on capital. When you're looking at more absolute return type investments, then they're going to have a lower degree of hedging and that's really thing if you're looking at venture capital which is just going to be looking to drive big outcomes, then currency risk is going to have a smaller delta and overall returns.

So on the capital side, the things where you're looking to slow and steady rinse the waste type allocations, then currency risk can be more destructive to returns. And then interestingly with the Aussie dollar is correlation with underlying equity markets for example fluctuates, but when you are looking in low yielding environments, so when you see straight out of COVID, straight out of the gfc, the Aussie dollars correlation to equity markets becomes pretty strong. So we saw in post the GFC for example, s and p rallied by 90%, but Aussie went from 60 cents to a dollar 10. So if you just had an s and p index fund post the gfc, you only normally participated at 14% of the 90% rally. Its impact on returns depends on asset classes and can vary over time

POC:

Given where the a dollar value is at against the US dollar currently, do you view this as low compared to true value, whatever that true value is, as I sort of mentioned in my opening comments,

Thomas Averill:

Yes I do and yes we do. As of firm, you're right, you mentioned to the long-term ranges of Aussie us but the real, if you like, non black swan floor, it's typically around 65 cents, right? It spend very little time below 65 cents. You obviously saw the GFC sent it to 60 COVID, sent it to 55, and then the sort of fed sent it into the low sixties and then Trump sent it to 59. Outside of those big macro shocks, you've seen the Aussie obviously bounce relatively aggressively off the 59 as Trump has walked back his tariff aggression. Yes, we do view down here as value undervalued from a PPP standpoint, the dollar is also significantly overvalued. So when you look at the dollar potentially losing yield support or losing some of its support against a big deficit and Trump pushing back from a global agenda, all of those things we think so it's not just an Aussie dollar story but concerns about the strength of the green back on over the longer term.

POC:

Whilst we're seeing some moderation in the Trump's administration use of tariffs, what impact have the increased US tariffs had on the A UD and what do you think will be trump's longer term impact on the USD?

Thomas Averill:

So the immediate aftermath was this kind drop down in the US down to 59 cents as Trump really rallied risk markets across the world and Australia's reliance on Chinese trade being a driving force of that initial market reaction. But then the kind of lens has shifted more from enabled these two competing forces. One is the impact on global trade and China in particular and the impact on the sie dollar. And then the other one is how much actual destruction is Trump going to do to domestic the US domestic economy, not just from tariffs but also he is talking about trying to remove $2 trillion worth of public spending, which is about so 6% of US GDP. Now I think if you get the market more concerned about US domestic economic destruction and that playing out in greater curve inversion for the US interest rates than I think that's pretty Aussie US supportive largely most of his tariffs haven't really been followed through on and I think that that's typical of Trump's negotiating style that he goes incredibly aggressive knowing he's going to have to walk back from there.

I also think he's been quite surprised at how the markets taken it so expect Trump to continue to moderate his position and aie us to be reasonably well supported as a consequence of that. But longer term I don't think his policies either, but to be short of his bureaucracy ones be that good for the US economy, I think he's really done some hammer blows to overall confidence and despite the fact that he's walking back, loss of the damage has been done in terms of international relations, American reliance is no longer there. So I think you're going to see lots more trade agreements and bilateral stuff done exclusive of the us. So I do see the US exceptionalism and US reliance diminishing over the longer term and that which also is going to impact appetite for US debt, which is way worse than it was in 2010 when Oz US was a dollar 10. So I'm a long-term bear on the dollar.

POC:

Do you think Moody's downgrade of the US credit rating there sort of trumps tariffs and his first few months in power have pushed them over the edge to make that decision or do you think it was inevitable with just that ongoing debt that's piling up in the us?

Thomas Averill:

Yeah, arguably it was inevitable really because also I think the bigger thing for them is he's got this proposed tax cut which potentially makes the fiscal position of the country worse. And you've also got to remember that Moody's is one of the few agencies that hadn't already downgraded the US so I think it was just a matter of time before they just joined. I think it was Fitches who already did it, who were the ones that did it thousand 10,011. I don't think it's particularly a knee jerk reaction to them. The US debt is apart from Japan, which has a really great ability to recycle debt within its own economy is the biggest in the western world as a proportion of GDPA long way where you compare that to Australia. All the domestic headlines might say that we're a bit skinned. We have one of the best balance sheets in the OECD, which again leaves us relatively well placed to perform strongly.

POC:

China appears to be structurally slowing and given their Australia's largest trading partner, could this mean the Aussie dollar will remain lower for longer against the USD? And are there any other macroeconomic risks that you are seeing on the horizon?

Thomas Averill:

I think the Australian dollar is always going to be a volatile one and look, although we have a core view that Aussie US goes higher, I think the volatility is going to remain a keen feature here. So I don't think it's going to be a straight line journey. With regards to China, there is obviously concerns about debt in the system and slowing growth, particularly issues with real estate. The retreat of the US from the global economy to a certain extent or an America first policies does create a vacuum for China to fill. And if you look at how China has grown to where they're now over the last 20, 30 years they've followed, which is ironic, really a post second World War America playbook where they were the biggest infrastructure investor globally, which allowed them to gain the influence that the US has gotten. Shit is now. But I think that void is going to be or is already being filled by China will continue to do so despite the domestic slowdown concerns, actually think that China is going to remain a big global investor and Australia will benefit from that tailwind. So I think there's some short term, medium term potentially issues, but you got to remember China's still like a billion plus people with a gray middle class. So I don't think the China story is over at all.

POC:

Yeah, it's interesting. I think we saw it in Trump's first term where the focus of the policies were far more internal and pulling back from globalization and to a degree resitting their position for the role in the world. So for mine, I guess that could lead to longer term geopolitical risks and as you say, China will step into fill the void. We've seen Russia also trying to open up trading with certain countries there. So yeah, I think longer term it'll be interesting whether this internal of the US government last beyond Trump's current term

Thomas Averill:

On that over key point. Even if he gets hammered in the midterms and loses to the Democrats the next election or the Republicans lose the Democrats, the next election and American people vote for something different. I think the rest of the world has gone right. Well, America has now elected this guy twice and has voted so it's not just a Trump thing. Rest of the world now doesn't think they can trust the American public. So you're going to see Europe if you, you've probably seen this from an asset allocation, CE, European defense stock, ETFs spring up all over the place and defense. So everybody is now investing on the assumption that they can no longer rely on America and you're going to see that in the way that you already are seeing it in the way governments are acting, even if there is a reversion of course in the US political scene, I think wheels have been set in motion now that can't be turned around.

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POC:

Moving to Australia, have you got any thoughts on the impact of the federal labor's recent federal election win and whether this will be a positive for Aussie dollar growth and returns obviously in your fund?

Thomas Averill:

That's an interesting one because I mentioned this in the presentation the other day and it's probably the Australian election was one of the biggest non-events ever from a markets perspective. They were both parties, if you look at those sort of economic policies were campaigning on the same two key issues being the cost living and housing. So there wasn't a lot to set them apart on core key economic issues. Migration for example is a sort a hot topic for voters but actually is not as influential from a overall economic outlook standpoint and Australia, although it has its differences as politically polarized as other parts of the world, I think generally markets preferring the known entity, the incumbents. So I would argue potentially that the labor party are staying in should be relatively constructive for the Aussie dollar, but largely irrelevant.

POC:

Yeah, I hear you. It seems to become less and less relevant. Our federal elections, we know the party want to stick their neck out for anything too structural in reform or anything that may risk losing seats in more marginal electorates. So

Thomas Averill:

There's two sides that some of that's frustrating that everyone's so worried about getting elected that nothing ever changes and you've got short your very short terms in Australia. So I think that's the downside of it. But when you look at societies that are actually both parties of center right and center left, that's usually a sign of a relatively well-functioning society which doesn't have, for example the levels of extremist wealth gap that you've got in the US and parts of Europe.

POC:

Yeah, very valid point. You've got to keep a healthy and large middle class. Obviously it should be one of the long-term aims of all the political parties we've been sort of musing on all of the global issues going on has all of these risks. We've been talking about impact on returns in the Rochford fund.

Thomas Averill:

As you pointed out, our fund provides a three x exposure to the dollar versus the US dollar. So really it's impacts the dollar impacts self fund by magnitude of three. And what we try and do again because of our background in treasury, although we don't actively manage the currency exposure, we do actively manage the cash of the fund to make sure that the liquidity of the fund is maximized all time and then we invest that cash to then achieve total cost recovery for investors to allow investors to have a kind of straight through participation. And where that's good is it means you can accurately allocate if you're trying to achieve a specific level hedging within your portfolio, you can accurately allocate to our fund to do that. That would be the main driver.

POC:

I guess in simplistic terms, if we do see the a dollar appreciating against the US dollar, it's going to generate three times leverage returns

Thomas Averill:

On

POC:

That exposure within your fund.

Thomas Averill:

I mean hugely, right? So let's say that we do get back to fair value, so we get back to 75, that's going to be a 50% plus return in our fund,

POC:

Quite a significant return that should obviously be thought about and how it will offset potential losses in equities due to the currency movement there. So it's about balancing I guess the thought of how this fund would be used in alignment with the rest of the growth offshore growth assets in a portfolio.

Thomas Averill:

And it's going to your earlier point around how currency hedging plays into asset allocation. I think if you've got US dollar nominated assets in there that are more income distributing assets or not high growth, they're the ones that you should be looking at from a hedging or de-risking from a currency standpoint. Also, if you've got US dollar denominate assets that you're not going to be holding there in for the long term. So medium term volatility is going to have an impact and again, it's those kind assets. Hedging can be more important for overall returns.

POC:

I mean you deal a lot with the investors that are using your fund and what's the feedback in terms of how they're using the Rochford fund and what they're trying to achieve and does that align with how you've envisaged the fund would be used?

Thomas Averill:

I believe so We have some SMA managers that use our funds and some other big wealth platforms actually consider allocation to our fund, actually describe it in their tools as a hedge. Again, sort of advantage, one of the main advantages is of the accuracy in which you can allocate to our fund. So if you want to say reduce your exposure to the US dollars in a particular asset by 50%, then a 16.6 allocation to our fund will achieve that. And as I say, we have a cash management strategy that helps the fund achieve cost neutral also because of the economics of scale that the Radford relationship brings to the fund, we do over 20 billion in derivatives. The underlying derivatives that we execute in the fund cost half a currency point, so the fifth decimal place. So we've really negotiated institutional grade execution within the counterparty relationships with the fund has.

POC:

I think it's an important point. You touched on there, Tom, the size, the exposure. Could you maybe touch on that again? So if I wanted to hedge a hundred dollars exposure in my portfolio to USD, what sort of allocation would I be looking at in your fund?

Thomas Averill:

So if you wanted to hedge a hundred percent of that hundred dollars, then that would be $33.33 because it's exactly three times

POC:

Which Yeah, correct. As you said, the leverage in the strategy there, I mean I guess in the wealth management market there has been really a lack of opportunity for individuals to take on, well two hedge currency exposure and US dollar exposure in their portfolio. Obviously in STO investors, the very largest investors in Australia, they have the resourcing and capability to be able to directly, I guess engage a business like yours to assist. But are you aware of any other competitor peer strategies? And if you are, how do they actually differ to your product?

Thomas Averill:

There is a primary competitor in Australia that has a listed ET tf, but the way that they provide the leverage and if you like the quickest to market or the cheapest way to provide leverage in a currency fund is via futures. If you provide it via futures, it means you're subject to, well one, I think futures are more expensive than OTC and also you want to deal in lot sizes. So getting it absolutely accurate and the rebalancing is challenging. Also, you have to have cash at your futures broker for daily margining with futures. Now that is not the way, if you like institutional overlay works within institutional A. You go and negotiate direct bilateral leverage facilities with investment banks, which means that you actually have your cash available to invest and get some yield return in the fund because we had that institutional labor a experience and the relationships with those banks, that is how the Broadford fund has achieved its leverage by what's known as IS and CSA agreements with our investment banking counterparties as opposed to just going straight off the market and giving futures, which to be honest doesn't really provide that much value to an individual investor because an individual investor could trade futures themselves on one of those, the stock brokerage programs.

So we've actually tried to put a wrapper around institutional grade solution and then access to wholesale investors via platform such as Netwealth.

POC:

What type of return would you be getting on the cash collateral? As you point out when you're actually implementing hedging using futures, the cash is stumped up with the exchange and you get a 0% return on that cash.

Thomas Averill:

So at the moment we getting on our cash, we're getting roughly about RBA. We were doing a bit when the curve was not interest rate curve was inverted, we were getting a bit better than that with term deposits. We have to be careful about how much we put on term given that the fund is daily price and daily liquid that we have to have liquidity available to our investors. There is also interest cost in the underlying derivative, which has been, and that's this idea of carry. Now, if you buy a higher yielding currency, you receive the carry. If you are selling a high yielding currency, you have to pay the carry. Now for the last, while the fund's been existing, we've actually been negative carry because US rates have been higher than in Australia and that's been a big cost of the fund because that's multiplied by the leverage. If we're in a situation where US funds fall below that of Australia, US interest rates fall, then the fund not only earns the interest on its cash but also earns carry. Now that doesn't look like it's imminent, but I think that should happen within the next six to nine months.

POC:

Well, I'd imagine structurally long-term Australia's typically had higher rates than the us it has to attract capital to our country. So I would've thought over the long-term you could expect to also get some smaller return out of the carry component in your strategy.

Thomas Averill:

We expect that to occur too. I think the Fed was a bit on the sidelines last time around, but we expect this economic slowdown in the US to probably be a bit starker than the market is currently predicting and the Fed to have to go a bit more aggressively than the market is currently predicting. But that's more likely to happen in the backend of this year than imminently. But I think fed cutting, we talked about Aussie returning to 75. I think fed cutting would be a prerequisite for that to happen.

POC:

Maybe finally, can you provide a bit of a summary on how your strategy actually implements the currency hedging in the fund? You've touched on obviously the use of over the counter derivatives, but yeah, I think that'd be of good value to the listener and certainly myself educative.

Thomas Averill:

Absolutely. So it's not QC complicated in terms of that we execute basically forward and swap currency transactions. The swaps are just to manage the maturity profile, which we also try and manage to maximize the liquidity, but simply put on a daily basis we net settle the investments and redemptions typically off a fix to make sure all investors are treated equally and that we achieve excess execution. As I mentioned earlier, we have fixed execution spreads from our counterparty, which is basically 50 bucks a billion, so half a basis point basis on the basis fifth decimal place of Aussie US exchange rate. So incredibly competitive execution, which your listeners wouldn't get access to if it wasn't sort of getting aggregated up through the relationships that we have.

POC:

No. Well, Tom, it's been a really fascinating discussion with you today. Something that I haven't spoken to a currency portfolio manager previously on the podcast series, so I know it's certainly been an educative session for myself and I hope also for the listeners there too. So I thank you for joining us on the podcast today and certainly wish you all the best with the fund. When I think I first started, well first met you maybe 18 months, two years ago, it certainly struck me as a product and an investment strategy that I'd like to understand a little deeper because there's not a lot of competitors in this marketplace, and I do think that particularly in the growing area of managed accounts and the number of consultants running portfolios on our platform now we're getting more sophisticated, I guess, insights, quasi insto insights into managing portfolios. So I certainly think this could be an option for those wishing to hedge USD exposure in potentially a more efficient way than buying and selling out of a hedge and an un hedge fund there, Tom. So certainly wish you all the best with it.

Thomas Averill:

Thank you very much, Paul. I mean, just actually on that last point there you say, yeah, if you're switching between hedge and un hedged, obviously going to realize capital gains events, whereas with our fund, that won't happen. So our fund does allow you to adjust your hedging ratios just by rightsizing your allocation to our fund rather than having to switch from one underlying hedge unit class to another.

POC:

Well, thanks again, Tom. Have a great afternoon. To the listener, thanks for joining us again on another installment of the Portfolio Construction podcast series. I hope you've enjoyed the macro musings of the earlier discussion on today's podcast and then also finishing with some direct insights into how the Rochford Ford Fund works and how it's, I guess, fairly unique at the moment in terms of products that I've seen available on our investment menu. So I hoping you have a great day and look forward to you joining us again on the next installment of the podcast series.