- What does hedged and unhedged mean?
- How does currency affect ETF returns?
- Unhedged vs hedged – what should I do?
- Unhedged vs hedged returns comparison
What does hedged and unhedged mean?
When investing in global ETFs, you will be investing in the local currency of that market (such as the USD, Euro etc…). This is why the question of hedging vs unhedging becomes a consideration for investors to manage currency risk.
Hedging means that the ETF issuer has converted the underlying assets from their home currency to $AUD. The exchange rate is locked in at a certain price and won’t be subject to currency fluctuations. For example, the BetaShares Gold Bullion ETF – Currency Hedged (QAU) is an $AUD hedged Gold ETF. That means that Australian investors have exposure to the USD Gold price. We recently compared the best gold ETF on the ASX for more information.
An unhedged ETF is fully exposed to the potential for currency fluctuations in the Australian Dollar (AUD).
How does currency affect ETF returns?
Changes in the value of the Australian dollar may affect the value of your investment. ETFs provide Australian investors with an ability to access overseas markets and securities not traded in Australian dollars ($AUD) and not available on the ASX.
This means that ETF issuers can choose whether or not to remove or ‘hedge’ currency risk. Some ASX listed ETFs are unhedged while some ETFs hedge currency exposure. Currency hedging also involves higher indirect costs of implementing the hedging instrument.
|Unhedged ETF||Fee||Hedged ETF||Fee||Premium for Hedging|
Unhedged vs Hedged – What Should I Do?
There is no right or wrong answer if ETFs should be hedged or not – it’s merely up to investor preference. You should consider your risk/return profile, your investment time horizon and assess the risk of the country you are investing into. Purchasing unhedged ETFs can be a good thing if the Australian dollar falls. However, the opposite occurs if it rises.
For example, if you are in retirement phase and rely on steady and stable income from bonds and shares, you may want a hedged ETF to alleviate any currency movements. You may have a particular view of the country you are investing in and how it will fair against the AUD. Foreign currency movements are one of the hardest markets to predict. Investors should treat currency hedging as a way to manage risk rather than adding return.
Unhedged vs Hedged Returns Comparison
Local investors who own unhedged global shares have enjoyed the double benefit of rising share prices and a falling Australian dollar. Over the last year the AUD/USD exchange rate has fallen over 10% from 0.71 to hover around 0.64, which explains why unhedged ETFs outperformed their hedged counterparts. The AUD even reached an intra-day low of US$0.57 in March 2020.
The falling AUD has meant unhedged ETFs returned on average 15% above their hedged counterparts. Hedged ETFs had negative performance over the last year whereas unhedged ETFs remained in positive territory. This shows how divergent performance can be explained by currency movements.
Stockspot believes investors should seek diversification across different currencies as well as different sectors and economies. The Stockspot portfolios are generally invested in unhedged ETFs for their diversification benefits. Unhedged ETFs provide better protection against domestic currency debasement and a weak Australian economy.
We prefer the unhedged ETF for clients as our portfolios are diversified across Australian share markets and defensive bonds and gold. This approach ensures risk is minimised for clients, while they’re aiming for higher returns.