Lesson 6 of 11 · Fund Mechanics · 1 min read
Currency Hedging
intermediate
Canceling out FX swings between your fund's currency and its holdings' currencies.
A currency-hedged ETF uses forward contracts to offset the effect of exchange-rate movements between your fund's currency and the currencies its underlying holdings are priced in. Without hedging, a Euro-based investor in a USD-denominated S&P 500 fund is exposed to both the S&P 500's performance AND the EUR/USD exchange rate — a strong dollar boosts returns, a weak one drags them down, independent of how the actual stocks did. Hedging strips that out, usually for a TER a few basis points higher.
Hedging doesn't remove risk. It swaps market risk for a currency bet you may not have wanted.
Unhedged
1
Underlying Return
e.g. S&P 500 in USD
2
+ FX Movement
EUR/USD swings pass straight through
3
Your Return
Stocks + currency, combined
Hedged
1
Underlying Return
e.g. S&P 500 in USD
2
FX Swap Cancels It Out
Small ongoing hedging cost
3
Your Return
Stocks only, FX removed
Key takeaways
- Hedging removes a specific risk (FX), it doesn't remove risk in general — you're still fully exposed to the underlying market's own performance.
- Over long holding periods, currency effects can partially wash out on their own — hedging is more often chosen by investors with a specific view on FX, or who want to isolate pure equity/bond exposure.
- Hedging isn't free — expect a modestly higher TER on the hedged share class of the same fund versus its unhedged twin.