Currency Hedging

Currency hedging is a strategy that some funds use to neutralize the effect of exchange rate movements on your investment returns. When you invest in foreign assets (like U.S. stocks) through a Canadian-dollar fund, your returns are affected by two things: how the investment performs, and how the Canadian dollar moves relative to the foreign currency. Currency hedging tries to remove that second factor.

How it works

A currency-hedged fund uses financial contracts (called derivatives) to lock in exchange rates, so that changes in the Canadian dollar don’t add or subtract from your returns. An unhedged fund lets the currency fluctuations flow through to your returns naturally.

For example, if U.S. stocks go up 10% but the Canadian dollar also strengthens by 5%, your return in an unhedged fund would be closer to 5% in Canadian-dollar terms. A hedged version would aim to give you the full 10%.

Example

Say you invest $20,000 in a U.S. stock ETF when the Canadian dollar is at $0.74 USD. Over the year, the U.S. stocks gain 8%. But the Canadian dollar also strengthens to $0.80 USD. In an unhedged fund, your return in Canadian dollars would shrink to about 0.5%, turning an $1,600 gain into roughly $100. In a hedged version, you’d get closer to the full 8%, or about $1,600. The reverse can happen too. If the Canadian dollar weakens, an unhedged fund actually gives you a bonus return.

Should you hedge?

It depends, and there’s no single right answer. Over short periods, currency movements can have a big impact on your returns. Over longer periods, they tend to wash out. Hedging also adds a small cost to the fund, which shows up in a slightly higher MER.

For a more detailed breakdown of when hedging makes sense and when it doesn’t, we have a full guide on currency-hedged ETFs. The key takeaway is that hedging isn’t free, and it isn’t always beneficial. Understanding what it does (and what it costs) helps you decide whether you want it in your portfolio.