Picking ETF's : Hedged vs Un-Hedged

Picking ETF's : Hedged vs Un-Hedged

ETFs or exchanged traded funds are really picking up steam as of late. They have become the primary focus of many investment companies like WealthSimple or Montreal startup Mylo that solely use ETFs as their primary investment vehicles. ETFs are low-cost diverse funds offering exposure to many industries, markets and companies.

 

One thing that is imported to consider with ETF’s is looking at a hedged and unhedged ETF. The two options usually apply when an ETF is listed domestically but invests either in a foreign market or an asset (like gold) that is listed in a different currency. Hedged vs Unhedged usually works with hedging for currency risk.

Currency risk is the risk that an investor takes on when investing in a foreign currency as the local currency can appreciate/depreciate against the foreign currency causing gains/losses depending on the direction. Hedging refers to the practice of eliminating the currency risk. The way a hedged ETF works is that the ETF managers have set up forward contracts that have locked in the currency conversion rate ahead of time. This way the managers of the fund have effectively mitigated the currency risk. In an un-hedged fund, the local currency floats freely against the foreign currency - meaning you as the investor are exposed to the currency risk and the underlying asset.

Is currency risk bad?

This is a complicated question that does not necessarily have a right answer. Honestly, the answer depends on the forward outlook on the currency exchange rate. This involved looking at factors that would lead to the appreciation and depreciation of the dollar. Things like interest rates, bond yields, investor sentiment, drivers for the economy and political events will factor into the exchange rate. If we look at the CAD/USD rate today some of the main factors are NAFTA, oil (for the canadian economy), investor sentiment in Canada and interest rates.

The main goal with currency hedging is to reduce volatility in a portfolio. The FOREX markets are quite volatile and trade 24/7. There are also many external factors that are in play with currency that are not in the stock market and for some investors they rather limit their risk to the underlying asset only.

Disclaimer: All of the above is my own personal opinion. Both hedged- vs unhedged funds can be a good investment option depending on your investment goals. Please consult with a licensed representative before making any investment decision. Please do your research before making any financial decision.

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