Currency hedging with ETFs
Pure access
Currency fluctuations can have a significant impact on the performance of an investment. Selecting a hedged fund will ensure your returns are driven by the underlying investment, not the impact of exchange rates.
Avoid US overexposure
For many Australian investors, an international exposure is heavily dominated by US stocks. Currency risk can be reduced by selecting hedged funds as part of a diversified international portfolio.
Improve return consistency
Removing currency volatility may provide smoother and more predictable returns.
What does it mean to hedge currency?
Investing in international equities on an unhedged basis involves taking on additional exposure in the form of foreign currency and exchange rate movements.
Exchange rate movements can negatively or positively impact your returns.
Currency hedging your investments is a way to limit this impact.
How to hedge currency risk
Currency hedged ETFs are designed to hedge currency risk. The ETF issuer typically does this by entering forward foreign exchange contracts (or similar instruments) with a third party, enabling the buyer to set an exchange rate at a certain price for a certain period.
This means that when there is a loss in the value of the underlying ETF holdings that is attributable to currency movements, the forward contract is expected to provide an offsetting gain, and vice versa.
What is the difference between hedged and unhedged ETFs?
The objective of hedging is to minimise the influence of currency movements on your investment returns, which should instead be determined primarily by movements in the value of the underlying investment.
Investing in an unhedged international ETF means your investments will be affected by changes in the value of the Australian dollar. Investing in a hedged international ETF seeks to minimise the impact of these currency fluctuations.
When the AUD is rising in value against foreign currency, a hedged ETF would be expected to outperform an unhedged ETF with the same underlying investment exposure. Conversely, when the AUD is falling, the unhedged ETF would be expected to outperform the hedged ETF.
Factors that can affect currency movements
Differences in interest rates
One country’s higher interest rate may attract flows of money from other countries, in turn strengthening the home currency
A country’s current account deficit
A country spending more of its currency on importing products than what it receives from its exports may tend to face a declining currency.
Government debt
A country with high levels of debt is likely to see its currency decline as foreign investors look to sell their bonds in the open market.
Political stability
A country with more stability is seen as less risky for foreign investors, which entices capital away from other countries. This will potentially increase a ‘stable’ country’s exchange rate.
What sort of investors might consider a currency hedged ETF?
Investors who are looking to remove the currency variable
Some investors may not have a view as to which way the AUD will move in the short or long term. By investing in a hedged exposure, these investors can take much of the currency risk out of the equation.
Investors who think the AUD will appreciate
An investor may base their decision on their own tactical view on the direction of the currency. If they believe the AUD will appreciate against the foreign currency in which an asset is denominated, they could be better placed with an investment in a hedged international ETF over the relevant investment exposure.
Investors who want to hedge only part of their international exposure
An investor’s portfolio may play a role in the decision to currency hedge or not, based on the mix of defensive and growth assets.
Generally, more defensive international assets, such as fixed income, are included in a portfolio to act as a ‘buffer’ in declining markets, but currency movements could erode the value of these defensive assets when they are most required. An investor may choose to hedge these types of exposures.
On the other hand, historically unhedged global equities have tended to have a lower correlation to Australian equities than hedged global equities, and as a result, keeping equities exposure unhedged could improve an investor’s portfolio diversification.
Currency exposure as another source of diversification
Historically there has been a relatively low correlation between exchange rate movements and the performance of most of the other major asset classes. Many investors, therefore, see an exposure to currency movements as providing increased diversification to their portfolio.
Investors who hold this view may prefer to hold their international investments in an unhedged form.
In addition, diversification across various currencies can be beneficial, rather than only across various economies or sectors.
Investing involves risk. The value of an investment and income distributions can go down as well as up. Funds that use gearing magnify both gains and losses and may not be suitable for all investors. Before making an investment decision you should consider the relevant product disclosure statement (available at www.betashares.com.au) and your particular circumstances, including your tolerance for risk, and obtain financial advice. An investment in any Fund should only be considered as a component of a broader portfolio.
