Understanding Fund Risks · Mutual Funds

A global mutual fund can expose investors to both asset returns and exchange rate movements. The currency used to quote a share class does not, by itself, tell you whether the underlying currency risk is hedged.

Distinguish three different currencies

The assets have economic and trading currencies, the fund has an accounting currency, and the share class may be quoted in another currency. These labels can differ. Buying a class quoted in your home currency does not automatically remove the currency exposure of foreign holdings.

Combine the asset and currency effects

Suppose an overseas investment gains 8% in its local currency while that currency loses 5% against yours. Ignoring costs, the return in your currency is 1.08 times 0.95 minus one, or 2.6%. Adding 8% and negative 5% gives only an approximation because the two effects compound.

Read the actual hedge policy

A hedged class may use currency contracts to reduce specified exchange rate movements. Check the target hedge, adjustment frequency, currencies covered and permitted residual exposure. A class hedge does not necessarily remove every economic currency effect inside multinational businesses or every currency held by the portfolio.

Recognize the costs and imperfections

Hedging introduces transaction costs, operational requirements and counterparty considerations. Forward pricing reflects interest rate relationships and other market conditions, so the return difference between hedged and unhedged classes is not simply an insurance fee. Imperfect sizing and changing asset values can leave residual exposure.

Match the decision to the portfolio's job

Currency volatility can be especially material when a foreign bond allocation is intended to be relatively stable. For equities, the decision also depends on horizon, spending currency and overall exposures. Neither hedging nor leaving currencies unhedged is universally superior. Compare classes using their actual policy and total costs.

Try it yourself

A foreign asset is unchanged in local currency, while that currency appreciates 6% against your home currency. What is the unhedged return before costs?

Show the worked answer

It is approximately 6% in your home currency. A home currency label on the fund would not eliminate that effect unless an appropriate hedge actually applies.

Further reading

Educational material, not a recommendation to buy or sell a fund. Numerical examples are hypothetical. Fund terms, investor eligibility and tax treatment vary by product, account and jurisdiction.

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