International Shares Index Hedged vs Unhedged: A Comprehensive Guide

Imagine you've just made a substantial investment in international shares. You've done your research, picked the right markets, but one nagging question remains: Should you hedge against currency fluctuations or go unhedged? This decision can make or break your returns, and the stakes are high. Hedged vs. unhedged international shares investments could significantly impact your portfolio, especially during volatile times in currency markets. So, what does this mean for you, and how do you make an informed decision?

The Key Distinction Between Hedged and Unhedged Investments

Let's cut right to the heart of the matter: hedged international share funds aim to protect your investment from the impact of currency movements. When you buy a hedged fund, the provider employs strategies to neutralize fluctuations in exchange rates between your home currency and the currency of the investment region.

In contrast, unhedged international share funds leave your investment exposed to currency risks. This means that not only will your investment be subject to the performance of the international stock markets but also the ups and downs of the exchange rates.

In a scenario where your domestic currency weakens against the foreign currency, an unhedged investment may benefit from a currency boost, increasing your returns. Conversely, if your home currency strengthens, you might see a reduction in your gains—or even losses—despite the underlying shares performing well.

Hedged vs. Unhedged: Which Performs Better?

It’s tempting to ask: Which one should I pick for better returns? The truth is, there’s no universal answer. Performance will depend on the timing and nature of currency movements, which are notoriously difficult to predict. Let’s look at a simplified example:

Scenario	Hedged Returns	Unhedged Returns
Domestic currency weakens	10%	20%
Domestic currency strengthens	10%	0%

As this table demonstrates, an unhedged investment can amplify returns when the domestic currency weakens. However, in times of strengthening, those gains disappear.

Cost Considerations: Hedged Funds Aren’t Free

Another important factor is cost. Hedging isn't free, and the strategies used by fund managers to hedge currency exposure come with a price. Over time, the cost of maintaining hedges can eat into returns. This makes unhedged funds potentially more appealing to investors who believe currency swings will work in their favor or don’t want to bear the additional fees.

Why Hedging Matters in Times of Volatility

During periods of significant economic volatility—think global recessions, major political events, or crises like the COVID-19 pandemic—currency fluctuations can become more pronounced. This is where hedging can prove valuable, as it provides a layer of protection against the additional chaos caused by currency moves.

Consider the European debt crisis, where the euro fell sharply against major currencies. Investors who held unhedged European shares saw not only their stock values plummet but also took a hit from the weakened euro. Hedged investors, on the other hand, were insulated from that added currency loss, only suffering from the drop in stock prices.

Real-Life Application: A Case Study in Emerging Markets

Emerging markets are often more volatile than developed markets, not only in terms of stock performance but also regarding currency movements. Let’s take Brazil as an example. In 2020, the Brazilian real experienced sharp declines due to political instability and the effects of the global pandemic. Investors in unhedged international shares in Brazil faced substantial currency-related losses that compounded the negative returns from the stock market decline.

In contrast, hedged investors in the same market were protected from this currency depreciation. The impact on their portfolios was limited to the performance of Brazilian companies and did not include the currency risk.

The Role of Personal Risk Tolerance

This decision boils down to your personal risk tolerance and investment strategy. If you’re a risk-averse investor, hedging may make more sense. You’ll have more certainty over your returns and be shielded from the unpredictability of currency movements.

However, if you’re someone who can stomach a little more risk and are willing to bet that the domestic currency will weaken (or at least not strengthen too much), unhedged international shares could offer higher rewards.

The Case for a Hybrid Approach

In recent years, more sophisticated strategies have emerged, where investors can take a hybrid approach, combining both hedged and unhedged funds in their portfolio. This allows you to hedge your bets—literally—against both market and currency risks, providing a balanced exposure to both international stock market performance and currency movements.

A hybrid approach might look something like this:

Investment Type	Allocation
Hedged Funds	50%
Unhedged Funds	50%

In this scenario, you’re partially protected from adverse currency movements while still leaving room to benefit from any favorable fluctuations.

The Bottom Line: Hedged or Unhedged?

The decision to invest in hedged vs. unhedged international shares is more nuanced than a simple one-size-fits-all answer. It hinges on factors like:

1. Your personal risk tolerance – Are you comfortable with the extra risk that comes with currency fluctuations?
2. Market outlook – Are you investing in relatively stable developed markets, or are you venturing into more volatile emerging economies?
3. Cost sensitivity – Are you willing to pay a little extra to reduce currency risk, or would you prefer to keep your fees low and ride the currency waves?

Remember that no one can perfectly predict currency movements, not even the experts. Therefore, it’s essential to understand the trade-offs and how each approach fits into your overall investment strategy. Both hedged and unhedged options have their place in a diversified portfolio, and the right choice for you will depend on your investment goals, time horizon, and risk appetite.

Final Thoughts

In the end, whether you go hedged or unhedged, the most critical step is being informed. Both strategies come with their own sets of risks and rewards. By understanding these distinctions, you’ll be better equipped to make decisions that align with your financial goals. Balance is key, and it’s worth considering a combination of both hedged and unhedged international shares to ensure you’re not overly exposed to any one type of risk.

Ultimately, your approach to hedging should be part of a broader investment strategy, designed with your long-term goals in mind.