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1Clear out junk files and repair common Windows errors2Fix the driver behind crashes, sound loss and screen glitches3Repair Windows errors before they cause bigger problemsCurrency movements can materially change what an international stock investment earns in your own currency. Your result combines the foreign market’s local return with the change in the exchange rate between that market’s currency and your base currency. If the foreign shares rise but your home currency strengthens, the translated gain can shrink or disappear. If your home currency weakens, the same foreign-market gain can become larger in home-currency terms.
That currency effect is neither automatically good nor bad. It adds another source of return variability, and hedging can reduce it without selling the underlying foreign equities. Whether hedging improves an outcome depends on the investor’s base currency, the markets and currencies involved, the period, hedge ratio, interest-rate differentials, transaction costs, liquidity and the objective being pursued.
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What an international stock return includes
A foreign equity has a return in its local market. An investor who measures wealth in another currency receives a translated return instead. In simplified form:
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Home-currency return = (1 + local equity return) × (1 + currency return) − 1
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Here, the currency return is the change in the foreign currency’s value relative to the investor’s base currency. The formula includes a small interaction term: when both the shares and the currency rise, the combined result is slightly greater than simply adding the two percentages.
Example: a gain reduced by a stronger home currency
Assume a U.S. investor buys a euro-denominated stock index. The index rises 10% in euros, but the dollar strengthens 8% against the euro. From the investor’s perspective, the euro loses about 8% of its dollar value, so the approximate result is:
(1.10 × 0.92) − 1 = 1.2%
The local market gained 10%, yet the dollar investor earned only about 1.2% before fees and taxes. Adding 10% and −8% would give 2%, but the compounding interaction makes the exact result slightly different.
Example: currency amplifies a local-market gain
If the same index rises 10% and the euro strengthens 8% against the dollar, the translated result is:
(1.10 × 1.08) − 1 = 18.8%
The shares supplied 10 percentage points of local performance and the currency supplied an additional boost. Currency can also worsen a local-market loss or cushion it; the direction depends on the currency move relative to the investor’s base currency.
Why a strong dollar can hurt a U.S. investor’s international fund
For a U.S. investor, a rising dollar generally reduces the dollar value of foreign-currency assets when the fund leaves its currency exposure unhedged. The fund can report positive returns in local markets while its dollar share price falls or rises only slightly. This is the usual explanation when an international fund declines even though a foreign stock-market index, viewed in its own currency, increased.
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The reverse is also true. A weaker dollar raises the dollar value of foreign-currency holdings, potentially adding to gains or offsetting part of a local-market decline. “International stocks” therefore do not have one fixed currency behavior: a global fund may hold euros, yen, pounds, Swiss francs, emerging-market currencies and others, each moving differently against the dollar.
Unhedged, partially hedged and fully hedged exposure
Currency policy determines how much of the foreign-currency exposure remains in the portfolio. The labels below describe the target exposure, not a guarantee that realized exposure will be exact.
| Approach | Currency exposure | What drives results | Main trade-off |
|---|---|---|---|
| Unhedged | Most foreign-currency exposure remains | Local equity performance plus currency movements | Full participation in favorable currency moves, but greater home-currency volatility |
| Partially hedged | A stated portion is hedged, such as 50% | Local equities, the unhedged currency share and hedge gains or losses | Reduces some currency risk while retaining some currency diversification; the chosen ratio is not universally optimal |
| Fully hedged | The manager targets near-zero exposure to selected currencies | Local equities, forward or other hedge results and hedge costs | Less exchange-rate variability, but less benefit from favorable currency moves and possible implementation costs |
“Fully hedged” does not mean the portfolio is risk-free. Equity prices still fluctuate, currencies can move between hedge resets, and a fund may not hedge every currency or may use an imperfect proxy. The hedge can also create gains or losses that differ from the spot exchange-rate change.
How currency hedging works
Hedging aims to offset some exchange-rate exposure while keeping the foreign shares. Professional currency-management frameworks use spot transactions, forward contracts, options and foreign-exchange swaps. A fund commonly sells the expected foreign-currency value forward in its base currency. If the foreign currency falls, the hedge can gain and offset part of the loss on the shares’ translation. If the foreign currency rises, the hedge can lose while the unhedged asset gains.
Why a hedge has a cost
Forward pricing reflects, among other factors, the interest-rate difference between the two currencies. When short-term rates differ substantially, rolling a hedge can produce a meaningful positive or negative carry. Transaction costs, bid-ask spreads, liquidity, collateral requirements, counterparty arrangements and the timing of hedge rolls also affect results. A hedge that appears cheap in one period can be expensive in another.
What a hedge cannot do
- It cannot guarantee a higher return than leaving currency exposure open.
- It does not protect against a fall in the underlying foreign shares.
- It cannot remove every currency effect when holdings, hedge dates or instruments do not match exactly.
- It can reduce a favorable currency gain as well as an unfavorable currency loss.
What historical evidence shows—and what it does not
Historical findings are conditional on the investor’s base currency, market sample, dates and method. They should not be treated as a universal forecast.
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MSCI analysis for U.S. dollar investors
In MSCI’s analysis covering January 2010 through June 2024, U.S. dollar investors who hedged several international markets experienced lower risk and higher returns than unhedged investors in the index analysis. Japan was an exception for risk: hedging increased risk there. MSCI linked that result to the unusual relationship between Japanese equities and the yen-dollar exchange rate. The finding applies to that sample and perspective, not to every investor or future period.
In a separate analysis of the MSCI ACWI ex USA Investable Market Index from December 31, 2021 through June 28, 2024, currency movements eroded the gains that local equity markets produced for a U.S. dollar investor. That is a description of the specified index and period, not a general prediction that currencies will always subtract from international returns.
Why hedge ratios cannot be universal
An MSCI analysis using data through June 30, 2025 emphasizes that the effects of hedge ratios differ across currency pairs and investment objectives. Short-term interest-rate differentials influence hedging costs, so a ratio that reduced volatility in one currency pair or period may not deliver the same result elsewhere. Risk reduction, total return and risk-adjusted return can point to different decisions.
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A 2016 CFA Institute digest summarized a study in which factor-based, long-short country equity-index portfolios generated annual excess returns of 7%–12% in U.S. dollars without hedging. The figure belongs to that specific strategy and study; it is not a typical diversified-investor return, a forecast or a measurement of the currency contribution to a broad portfolio. The digest also reported that exchange-rate movements did not offset the country equity return differentials in that sample.
A fair comparison of hedged and unhedged funds
Before comparing two funds or share classes, align every relevant dimension:
- Base currency: Measure both results in the currency in which you spend and assess wealth.
- Market and index: Confirm that the funds hold comparable countries, sectors, market-cap segments and currencies.
- Hedge ratio: Identify whether exposure is unhedged, partially hedged or targeted at full hedging.
- Dates: Use identical start and end dates. Currency regimes can change quickly.
- Objective: Decide whether the comparison is about volatility, total return, downside protection or risk-adjusted return.
- Costs and implementation: Include fund expenses, forward-roll effects, interest-rate differentials, trading costs and any liquidity or market constraints.
A fund’s “hedged” label may refer only to major currencies, a monthly or quarterly target, or a share class whose hedge is maintained against a particular base currency. Read the methodology and reporting currency rather than assuming that the label means every currency exposure is eliminated.
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How to decide whether hedging fits your situation
Step 1: Identify the currency that measures your goal
Use the currency in which you expect to pay future expenses or evaluate your financial plan. A Canadian investor, a U.S. investor and a euro-area investor can hold the same foreign shares and experience different translated returns.
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Step 2: Separate the equity decision from the currency decision
First decide whether the foreign market belongs in the portfolio. Then decide whether the currency exposure is a desired diversification source or an unwanted source of volatility. Hedging does not make an unattractive equity market attractive; it changes the currency component.
Step 3: Choose a policy you can maintain
Unhedged exposure is simple and allows currency movements to flow through. A partial hedge can moderate swings without making a single all-or-nothing call. A full hedge may suit an investor whose liabilities are tightly linked to the base currency and who prioritizes reducing exchange-rate variability. None is automatically superior.
Step 4: Check the fund’s actual implementation
- Read the stated hedge percentage and rebalancing schedule.
- Check which currencies are hedged and whether smaller exposures are grouped into a proxy.
- Review the fund’s historical tracking difference, not just the spot currency chart.
- Look for disclosures about forward instruments, collateral, counterparty exposure and expenses.
- Compare the hedged and unhedged versions of the same or closely matched index when possible.
Step 5: Reassess for changed objectives, not short-term currency headlines
Exchange rates are difficult to time consistently. Revisit the policy when your spending currency, time horizon, risk tolerance or liability structure changes, rather than switching solely because the dollar or another currency had a strong recent move.
Common mistakes and how to diagnose them
Comparing local and home-currency returns
A local index return and a fund return in your base currency are different measurements. Confirm the currency of each performance number before concluding that a manager underperformed.
Assuming a positive local return must produce a positive portfolio return
A sufficiently adverse currency move can overwhelm a local equity gain. Use the compounded formula, not local performance alone.
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Calling a hedge a free insurance policy
Hedges have carry, trading and operational costs and can lose money when the foreign currency appreciates. Evaluate the complete hedged share-class return.
Generalizing from one country
Japan’s result in MSCI’s January 2010–June 2024 analysis illustrates why a relationship observed in one market should not be extended to all countries. Currency-equity correlations can change with monetary policy, valuations and economic shocks.
Using a strategy statistic as a personal expectation
The 7%–12% annual excess-return figure reported in the CFA Institute digest describes a factor-based long-short country strategy. It is not an estimate for a conventional international index fund or a household portfolio.
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MSCI’s 2011 paper, Global Investing: The Importance of Currency Returns and Currency Hedging, summarized the central risk plainly: “An adverse movement in the exchange rate can dramatically change the performance of an international investment.” CFA Institute’s 2026 educational reading similarly frames currency as material to both returns and risk: “Exchange rates are volatile and, at least in the short to medium term, can have a marked impact on investment returns and risks—currency matters.”
The practical conclusion is precise rather than predictive: international-stock performance in your own currency is a joint outcome of foreign equities and exchange rates. Hedging can reshape that outcome, sometimes reducing risk and sometimes reducing return, but no hedge ratio is best for every market, investor or period. Compare like with like, carry the base-currency perspective through every calculation, and treat costs and implementation details as part of the return rather than as footnotes.
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