When to use a currency-hedged ETF

Last week, iShares launched Europe's first currency-hedged exchange-traded funds. They are a valuable addition to investors' armoury - but when should you use them? Paul Amery explains.

Last week, iShares launched Europe's first currency-hedged exchange-traded funds (ETFs). These allow investors to remove the currency risk component from three popular global equity indices: the MSCI Japan (available in a euro-hedged version only), MSCI World, and the S&P 500 (these are offered in both sterling- and euro-hedged versions).

The advantage of currency hedging is that you can split the investment decision regarding the underlying market from your view on its currency. Want to buy US shares, but concerned about the dollar? Buy a hedged S&P 500 fund. Feel that Japan's stockmarket is bottoming, but worried that the yen is vastly overvalued? Consider the hedged MSCI Japan ETF.

But you can look at these things the other way round, too. I've been an investor in Lyxor's Japan Topix ETF since early 2008. In domestic currency terms the Topix is well down since then. But as a sterling-based investor I'm actually up on my purchase price, due to the pound's weakness over the same period. If I'd bought a currency-hedged Japanese fund, I'd have foregone all those FX gains.

Currency hedging can also cost money if you're hedging from a high-interest rate currency to a lower-rate one (though you pick up a premium if it's the other way around). But with near-zero rates in most major FX blocs, this isn't a major concern right now. You also need to beware being sold the right product at the wrong time. In the US ETF market, for example, there was a clamour for funds offering currency-hedged exposure to foreign stocks earlier this year as the euro collapsed to $1.18. But you'd have missed out on a 17% rally in the euro since May if you'd followed the majority view.

All of this means that even if you're buying a currency-hedged investment, it's not sufficient just to have a view on the underlying market: you need to consider the currency regardless. But these new funds are still a valuable addition to investors' ETF armoury. If you feel that global stockmarkets are due a bounce, but also that sterling is so beaten up that it, too, may recover, then a currency-hedged fund is an ideal choice.

Paul Amery edits www.indexuniverse.eu .

Recommended

Should we adjust our all-weather ETF portfolio for inflation?
ETFs

Should we adjust our all-weather ETF portfolio for inflation?

It’s too early to batten down the hatches for our ETF model portfolio, but price pressures are increasing.
12 May 2021
Three commercial property funds that go beyond offices and shops
Property

Three commercial property funds that go beyond offices and shops

When it comes to commercial property, these three real-estate investment trusts in promising niches look most appealing, says David Stevenson.
11 May 2021
Why ESG investing is becoming the norm
ESG investing

Why ESG investing is becoming the norm

A lot of investors say they want to put their money into “ESG” funds. But unless you actively opt for a “sin” fund jammed full of companies behaving b…
10 May 2021
Micro-cap stocks: how to get huge returns from tiny firms
Small cap stocks

Micro-cap stocks: how to get huge returns from tiny firms

Micro-cap stocks are often overlooked, but the British market has plenty of them and their potential is massive. Max King picks the best two investmen…
3 May 2021

Most Popular

How will Joe Biden’s capital gains tax rise affect crypto prices?
Bitcoin & crypto

How will Joe Biden’s capital gains tax rise affect crypto prices?

The US president wants to increase capital gains tax – and that’s going to hit a lot of American cryptocurrency speculators. Saloni Sardana looks at h…
14 May 2021
Inheritance tax planning: the rules around gifting
Inheritance tax

Inheritance tax planning: the rules around gifting

There are plenty of legal ways to minimise an inheritance tax bill. Perhaps the simplest is to give away assets to reduce the size of your estate. Dav…
11 May 2021
Are we nearing the end of the negative bond yield era?
Government bonds

Are we nearing the end of the negative bond yield era?

As inflation gets going, the era of the negative bond yield – that investors have to pay governments for the privilege of lending them money – might b…
14 May 2021