What is currency hedging?

Investing across different geographies and currency areas can be a good way to help diversify a portfolio1

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Historically, the Australian dollar (AUD) has been seen as a ‘risk currency’ relative to the USD, meaning it typically depreciates in response to a negative change in risk sentiment (and vice versa). This means that, for Australian investors in US equities, unhedged exposure has tended to cushion AUD returns in times of market volatility.

International investing often comes with exposure to foreign currency movements, which can have a significant impact on returns. The more volatile the exchange rate between two currencies, the higher the risk and potential impact on returns. For investors wishing to reduce this volatility, currency hedging can help minimise unintended currency bets.

Currency risk arises from the change in price of one currency versus another. In the same way that companies’ shares rise and fall in value, so do currencies, when compared with one another. When buying or selling an investment denominated in a currency different than your base currency, the exchange rate of this foreign currency with the base currency forms part of the investment returns.

Hedging in currency risk

In the case where an investor might have a negative view on the foreign currency, they may want to get exposure to the underlying market. By hedging the currency risk in their investment, the portfolio is getting exposure to a foreign asset, but without getting exposure to the foreign currency of that asset. Although often overlooked, currency exposures can be significant drivers of both risk and returns of a portfolio.

In unhedged exposures, the impact of currency movements can be either positive or negative. The aim of currency hedging is not to capture the positive movements and reduce the negative movements. Instead, it focuses on mitigating the impact of any currency movements on the underlying investment return so that investors’ returns are based on the performance of the underlying asset they sought exposure to.

Effectiveness of hedging under different currencies scenarios

Effectiveness of hedging under different currencies scenarios

For illustrative purposes only.


For investors considering reducing currency risk, hedging can help mitigate unintended currency bets. iShares ETFs offer a cost-efficient and practical solution to investors looking to mitigate currency risk in their portfolios. Explore our range of hedged & unhedged ETFs on the link below.