Currency Risk in International Investing: What It Means and How to Manage It
Currency risk is one of the least-understood dimensions of international investing. A UK investor in the S&P 500 can experience very different returns from a US investor — even if both hold the same underlying ETF — because of GBP/USD movements. Here's how to think about it, and when (if ever) to hedge.
What currency risk actually means
If you're a GBP-based investor holding a USD-denominated ETF, your total return has two components: the return of the underlying assets (US stocks) and the change in the GBP/USD exchange rate. If the USD appreciates 5% against GBP while the S&P 500 returns 10%, your total return is approximately 15.5% in GBP terms. If the USD falls 5%, your return is approximately 4.5%.
Currency-hedged vs unhedged ETFs
Most ETF providers offer both hedged and unhedged versions of major index funds. For example, iShares offers CSPX (unhedged S&P 500, in USD) and IGUS (GBP-hedged S&P 500). The hedged version typically costs 0.05–0.15% more per year in expense ratio, and the hedging itself has a cost related to the interest rate differential between the two currencies.
Academic evidence suggests that for long-term investors (10+ year horizon), currency risk tends to diversify away and hedging the equity exposure in developed-market portfolios adds more cost than it saves. For shorter horizons or portfolios where currency volatility materially affects spending needs, hedged products are worth considering.
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