Currency Hedging in International ETFs: Surprising Outcomes for Investors

When looking to diversify portfolios, investors often explore international markets through Exchange-Traded Funds (ETFs). This exploration brings them face-to-face with a crucial decision: to hedge or not to hedge currency exposure. In a comprehensive analysis of ETFs focused on various global regions, including Australia, Spain, Japan, Europe, the U.K., Germany, Korea, Mexico, and a general international category, the performance of hedged versus nonhedged ETFs over the past decade was scrutinized, revealing intriguing findings on returns, volatility, and expense ratios.

Performance and Volatility: Hedged vs. Nonhedged

The analysis began with a partition of ETFs into hedged and nonhedged categories, aiming to understand how protection against currency fluctuations impacts overall performance. Surprisingly, across all nine regions studied, hedged ETFs consistently outperformed their nonhedged counterparts over a ten-year period. The average performance gap was substantial, with hedged ETFs leading by 40 percentage points in total, or an annual difference of 4 percentage points. This advantage in returns did not come at the cost of higher volatility. On the contrary, hedged ETFs exhibited significantly lower volatility, with an average annual difference of 13 percentage points compared to nonhedged ETFs. This pattern held true across each of the nine categories examined, challenging the common assumption that hedging necessarily incurs higher costs and risks.

Expense Ratios: Expectations vs. Reality

A key concern for investors when considering hedged ETFs is the potential for higher expense ratios due to the cost of implementing currency hedges. However, the study found no significant statistical difference in the expense ratios between hedged and nonhedged ETFs. This revelation suggests that investors can enjoy the benefits of reduced volatility and improved returns without incurring additional costs. The finding undermines a prevalent barrier to choosing hedged international ETFs, highlighting that efficient hedging strategies may not necessarily lead to higher fees.

Implications for Future Investment Strategies

The analysis sheds light on the advantages of opting for hedged international ETFs over their nonhedged counterparts, especially in terms of returns and volatility. These benefits were particularly pronounced in a decade characterized by a strong U.S. dollar bull market. While it remains to be seen whether these trends will persist in the coming years, the findings underscore the importance of considering currency hedging as part of a holistic international investment strategy. Investors now have empirical evidence to weigh the potential trade-offs between hedged and nonhedged ETFs, enabling more informed decision-making in the context of global portfolio diversification.

This comprehensive review of hedged versus nonhedged international ETFs challenges prevailing assumptions and offers valuable insights for investors navigating the complexities of global markets. By carefully assessing the impact of currency fluctuations and the efficacy of hedging strategies, investors can make choices that align with their risk tolerance and investment objectives, potentially enhancing the resilience and performance of their international portfolios.

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