ETFs in Euros: Are They Currency Hedged?

Imagine that US stocks are rising, but the euro ETF that tracks that market shows a much weaker result.

The product may be working exactly as it should.

The difference may lie in the exchange rate.

One of the most common mistakes is to assume that buying an ETF or fund in euros means being protected from movements in other currencies. It does not.

The quotation currency is the currency in which the product is bought and sold on a given exchange.

Currency hedging seeks to reduce the impact of fluctuations between different currencies through financial instruments, usually derivatives.

They are two different characteristics.

The quotation currency does not determine the exposure

Consider an ETF that invests in US stocks and is bought by an investor whose wealth is measured in euros.

That ETF can exist in different combinations:

Quoted in EUR, unhedged. The investor buys the ETF in euros, but remains exposed to the currency movements associated with the assets in the portfolio.

Quoted in EUR, hedged to EUR. The share class uses hedging instruments to try to reduce the effect of currency fluctuations against the euro.

Quoted in USD, unhedged. The currency used for trading changes, but the economic exposure to the assets remains essentially the same.

Quoted in USD, hedged to EUR. A share class hedged to the euro can also be traded in another currency. The trading currency and the currency to which the exposure is hedged do not have to be the same.

The practical rule is simple:

do not judge your currency exposure by the currency in which you buy the product.

You need to understand which assets are inside the fund and confirm whether or not the share class includes currency hedging.

Why two ETFs on the same market can have different results

The 2020 example helps to show this difference.

After the fall caused by the pandemic, the S&P 500 recovered quickly and reached new highs. At the same time, the dollar lost value against the euro.

For a European investor without currency hedging, part of the gain in US stocks was eaten away by the currency movement.

A hedged share class behaved differently because it sought to limit that effect.

From 31/12/2019 to 31/12/2020, with net dividends reinvested. In dollars, the S&P 500 gained 17.8%. For an investor in euros, the hedged share class gained 15.1% and the unhedged class 7.8%, because the dollar lost 8.5% against the euro. Hedging also works the other way: at the bottom of the fall, on 23/03/2020, the dollar had risen 4.2% and the unhedged class was losing less (27.6% against 31.5%). Indices: S&P 500 (net, USD) and S&P 500 EUR Hedged (net); ECB reference exchange rate. Source: PortfolYou, based on index data. Past performance does not guarantee future results.

Neither product was necessarily working badly.

They represented different exposures.

That is precisely why two ETFs on the same index can show different results for a European investor.

Hedge or accept the currency risk?

Once you know whether there is currency exposure, another question arises: should that exposure be hedged?

There is no universal answer.

The decision depends on the asset class, the time horizon, the goals and the role the investment plays in the portfolio.

In bonds, currency fluctuations can account for a significant part of the total risk. That is why global bond portfolios are often hedged to the investor’s currency.

In equities, the relative weight of the currency tends to be smaller compared with the volatility of the stock market itself. Many long-term investors choose to keep some currency exposure.

Over shorter horizons, a significant currency move can have a greater influence on the final result, which makes this decision more relevant.

Annualized volatility of monthly returns from 2018 to 2025, for an investor in euros. The market itself is the version hedged to the euro; the currency effect is the month-by-month difference between the unhedged and the hedged versions. In global bonds, the currency moved almost as much as the market itself (4.1% against 4.2%). In global equities, much less (5.2% against 15.0%). Bonds: Bloomberg Global Aggregate (hedged to EUR; unhedged, converted from USD to euros). Equities: MSCI World (net, hedged to EUR and in euros). ECB reference exchange rate. Source: PortfolYou, based on index data. Past performance does not guarantee future results.

Hedging is not free either. It involves implementation costs, and its result can be influenced by the differences between the interest rates of the currencies involved.

What matters is that the decision is a conscious one.

Check before you invest

A label such as “EUR Hedged” in the name of a share class is usually a sign that there is a currency hedging policy against the euro.

But the name should not replace reading the product documentation.

Before investing, check:

• which currencies the underlying assets are in;
• in which currency the product is traded;
• whether there is currency hedging;
• to which currency that hedging is done;
• what the costs and limitations of that policy are.

It is also one of the characteristics to look at when choosing an ETF, as we saw in “How to Choose an ETF”.

Currency exposure is also part of the plan

The decision whether or not to hedge currency should not start when you choose a specific ETF.

It is a decision about the portfolio itself.

In the Investment Policy Statement, you can set the currency exposure the plan accepts and the parts of the portfolio where hedging makes sense.

After that, choosing the instrument becomes simpler.

In the end, an ETF bought in euros can still be exposed to the dollar, the pound, the yen or several currencies at once.

The currency you pay for the ETF in tells you how you buy it. Currency hedging tells you which currency risk it seeks to reduce. They are different decisions.

Adapted from “A diferença entre um activo ser cotado em euros e ter cobertura cambial”, originally published on the Future Proof blog.