Funds & Trackers
The currency a fund is priced in is not the currency of its risk
A fund quoted in your own currency can still rise and fall with exchange rates. Hedging changes that, at a cost, and only partly.
The options around currency exposure in a fund are set out side by side below, with the conditions that genuinely favour one over the other.
The difference in one place
- Trading currency and asset currency are different things and get confused constantly.
- Hedging costs money and the cost moves with interest rate differences.
- The relevant currency is the one you will eventually spend.
Three currencies, easily confused
A fund has a base currency for its accounts, a trading currency in which you buy it, and the currencies of the assets it holds. Only the third of those determines your actual exposure, while the first two are largely administrative conveniences for the provider. Buying a global equity fund quoted in your home currency does nothing to remove exposure to the currencies of the companies inside it.
People frequently believe otherwise, because the price they watch moves in a currency they recognise and can interpret instantly. A share class of the same unhedged fund quoted in another currency delivers the same underlying return with differently reported numbers.
What currency movement actually does
If assets are held abroad and your home currency strengthens, the value of those assets falls once converted back into your terms. If your home currency weakens, the same assets become worth more to you without anything having happened to the underlying businesses.
Over long periods currency movements have generally added volatility without a consistent direction, though the evidence varies by currency and by period. That means the effect is real and visible in any given year and considerably harder to characterise across several decades. For a portfolio intended to be held for thirty years, the currency question is more about the ride than about the destination.
What hedging does and what it costs
A hedged share class uses forward contracts to offset currency movement, aiming to deliver the local-currency return of the underlying assets. The hedge costs money, and a large part of that cost is driven by the interest rate difference between the two currencies involved.
Where it helps most, that cost is not fixed and can become substantial when rate differentials are wide, which is not knowable in advance. Hedges are also imperfect and reset periodically, so residual currency exposure remains even in a share class labelled as hedged. The ongoing charge of a hedged class is usually higher, and the hedging cost itself sits on top of that rather than inside it.
Where hedging is more commonly argued for
Bond holdings are the case most widely discussed, because currency volatility can comfortably exceed the yield those bonds are producing. A foreign bond fund left unhedged behaves far more like a currency position than like the defensive holding it was bought to be.
Put simply, for equities the underlying volatility is already large enough that currency movement forms a smaller proportion of the total. Many large companies also earn revenue in several currencies, so the listing currency overstates how concentrated the real exposure is.
None of this is settled, and reasonable practitioners disagree about equity hedging in a way they largely do not about bonds.
The spending currency question
The relevant currency is the one you will eventually spend the money in, which for most people is wherever they live. Somebody planning to retire in a different country has a genuinely different problem and a good reason to seek local advice about it.
Where it helps most, holding assets in the currency you will spend reduces the risk of a strong home currency eroding a portfolio just as you start drawing. That argument strengthens as the drawing date approaches and weakens the longer the horizon still stretching in front of you. It also applies far more forcefully to the defensive part of a portfolio than to the growth part.
Some of this will suit you and some will not, and that is the point.
What to check on your own holdings
The fact sheet states whether a share class is hedged, and it is genuinely easy to buy the wrong one by accident. Two share classes of the same fund frequently sit next to each other on a platform with almost identical names.
Check the currency breakdown of the underlying assets rather than the currency in which the price happens to be quoted. Decide once whether you want the defensive part hedged, write the reason down, and stop revisiting it after every exchange rate headline. Switching hedging policy in reaction to a currency move is market timing with an additional layer of cost attached.
Side by side
| Consideration | What it means in practice |
|---|---|
| Three currencies, easily confused | Trading currency and asset currency are different things and get confused constantly. |
| What currency movement actually does | Hedging costs money and the cost moves with interest rate differences. |
| What hedging does and what it costs | The relevant currency is the one you will eventually spend. |
The takeaway
The price on the screen is in a currency. The risk is in the assets. They are not the same question.
The version you keep doing is the version that works.
Questions readers ask
Does buying in my own currency remove currency risk?
No. It removes a conversion at the point of trade. The assets inside the fund are still denominated in whatever currencies they are denominated in.
Should I hedge my equity funds?
There is no consensus. The case is stronger for bonds, where currency volatility can dominate the yield, and weaker for equities, where it is a smaller share of total volatility.
