Key takeaways:

• Currency-hedged ETFs hold overseas equities, but the funds feature built-in hedging against foreign exchange movements 

• Currency ETFs can provide direct exposure to a currency pair, allowing an investor to effectively ‘bet’ on how a foreign currency will perform against the Australian dollar

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When it comes to investment returns, a number of different factors can ultimately affect the performance of one’s portfolio. The stock market is susceptible to a number of influences, be it monetary policy, geopolitics and conflict, regulatory action, commodity price cycles, the economy, and so forth.

However, one of the more overlooked variables that can play a role in shaping the performance of an investment is foreign currency exposure. This may be encountered in different ways.

For example, ASX-listed companies with global reach, and that derive a significant portion of their earnings in foreign currency, are exposed to the currency movements in the market(s) they operate. On the other hand, assets denominated in foreign currencies, like US shares, are also shaped by movements in exchange rates. 

As currency movements are often hard to predict, and also have the potential to act as either a headwind or a tailwind, investors may wish to manage their portfolio’s currency exposure. In this guide, we take a look at two different options.

Why Manage Currency Exposure?

The decision to protect one’s portfolio against foreign exchange movements is often dependent on the assets that an investor is holding. For example, this practice is more likely when it comes to stocks than it is with something like property.

Meanwhile, an investor will also need to make a conscious decision regarding currency hedging based on their risk appetite and investment views surrounding forex movements.

There is a train of thought among some investors that an unhedged portfolio can yield lower volatility across the long run. On the other hand, some investors feel that removing currency from the equation takes out one variable that they cannot control, or do not wish to speculate about, instead placing their conviction in the underlying stock or ETF they are investing in. 

While the above approaches would suit long-term investors, traders on the other hand may actively make an effort to hedge their portfolio for currency based on what exposure they think is necessary at that point in time. At the heart of this strategy is typically the accepted view that the Australian dollar is a ‘risk on’ currency associated with global growth.

Currency Hedging Strategies

1. Currency-Hedged ETFs

If you are looking to invest in foreign markets, but you are mindful of the role that foreign exchange movements may play, there are a number of ETFs that are designed with built-in currency hedging. You can spot these funds by looking at their names, as they will include a reference to being ‘hedged’ or ‘currency-hedged’.

These ETFs are effectively the same as their better-known variants that do not feature hedging. The issuer of the ETF will use financial instruments to smooth out the impact of exchange rate fluctuations over time, which means you won’t need to do anything to account for forex movements.

Be mindful, however, these ETFs typically attract slightly higher management fees to account for the hedging instruments.

Some of the options available to investors are shown below against their unhedged peers:

Hedged ETFs:

1. BetaShares NASDAQ 100 ETF-Currency Hedged (ASX: HNDQ)

2. VanEck MSCI International Quality (Hedged) ETF (ASX: QHAL)

3. iShares S&P 500 (AUD Hedged) ETF (ASX: IHVV)

4. Vanguard MSCI Index International Shares (Hedged) ETF (ASX: VGAD)

Unhedged ETFs:

1. Betashares Nasdaq 100 ETF (ASX: NDQ)

2. VanEck MSCI International Quality ETF (ASX: QUAL)

3. iShares S&P 500 ETF (ASX: IVV)

4. Vanguard MSCI Index International Shares ETF (ASX: VGS)

2. Currency ETFs

As an alternative to currency-hedged ETFs, there are various exchange-traded funds that offer direct exposure to currency pairs. This provides a number of advantages compared with trading risky derivatives or dealing in highly volatile foreign exchange markets.

These types of funds hold assets in a foreign-denominated bank deposit account. As such, when that currency rises against the Australian dollar, the net asset value of the ETF in AUD will rise by a corresponding amount. 

On the other hand, if a currency such as the US dollar retreats against the Australian dollar, the net asset value of the fund in AUD will decline in kind.

With this in mind, a currency ETF tends to be beneficial to an investor who thinks the Aussie dollar is likely to weaken against a foreign currency such as the Euro, US dollar, or the British pound sterling. In some cases, these funds may also generate income by way of interest earned on the deposit held with the bank. 

Investors with a significant tolerance for risk also have the option to back geared currency ETFs, which rely on leverage to magnify returns, but while also increasing exposure to magnified losses.

Some of the currency ETFs on the ASX include:

Currency ETFsBetaShares British Pound (ASX: POU)BetaShares Euro ETF (ASX: EEU)BetaShares U.S. Dollar (ASX: USD)ETFS Enhanced USD Cash (ASX: ZUSD)