Unhedged Int’l ETFs Can Hurt

July 01, 2011

It’s always surprised me that of the hundreds of international equity ETFs listed in the U.S., so few are currency-hedged.

I get that investors want to take positions on the relative strength of a currency or on the growth of a foreign economy. And I get that many people say the dollar is a decade-long secular decline. But that said, it seems odd that international exposure and un-hedged exposure should be so linked. It’s as if many investors aren’t even fully aware of what they’re getting into.

I’ve never been completely comfortable investing in foreign funds precisely because of the role currency fluctuations and central bank policies play in their returns. And, in a world of custom-tailored ETFs, it feels strangely inconvenient to have to do the currency hedging yourself.

In fact, it’s hard for me to believe that the vast majority of investors even want to be in an un-hedged currency position when they go long international stocks. And yet, the ETF market has outdone itself, providing ever-more options for exactly this kind of investment. And, in case you don’t realize it, the number of hedged ETFs out there is just seven.


A quick tally of un-hedged equity ETFs that only hold names priced in local currencies (i.e., no USD-denominated holdings) vs. currency-hedged ETFs. The difference is even larger if you include funds that hold a mix of local and USD-denominated equities.


If there’s one thing you can be sure of, it’s that currency exposure really can derail the returns of an international fund.

Just to be clear, a weakening dollar boosts the returns from an un-hedged foreign investment, and vice versa. So, any currency the dollar strengthens against will show a weaker performance. We've just seeen that with the iShares Turkey ETF over the past three months. The index the fund tracks was flat over that period—it returned just 35 basis points. But, as an un-hedged U.S. investor, you lost 4 percent, due to currency fluctuation alone.


TUR vs. Turkish Lira: 3 Mo

The index underlying the iShares MSCI Turkey ETF (blue) was flat over the past three months, but the fund (orange) lost 4 percent due to the depreciation of the lira (black).


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