Reasons vary for currency hedging

Written by Gary Silverman, CFP®

To hedge or not to hedge, that is the question. Last week we started to look at the effect of currency exchange rates on investing. What we found out was that when the dollar gets strong it hurts the return you see from your foreign investments. We then looked at hedging, which is a magical (yes, I’m still not going to explain it) way a mutual fund manager can eliminate the risk of currency fluctuations affecting your return. Today we look at whether or not you should hedge away the currency risks in your investments.

The first thing to consider is that hedging costs money, causing a drag on your portfolio’s return. Because of this, all things being equal, you would not want to currency hedge. Rarely, though, are all things equal. As we saw in my example last week of two virtually identical global bond funds, about half the time hedging helps and the other half hedging hurts. So what should you do?

First, unless you are an experienced currency trader you’re not the one doing the hedging. The question becomes, then, whether or not you should seek a mutual fund that hedges or not. There are actually three choices. Some funds hedge continuously, others never hedge, and others hedge occasionally. All three are useful depending on what you are trying to do.

Typically I use the unhedged variety. I use foreign investments because they do not mirror U.S. investments. The more they are different the better, so, for me, the currency fluctuations help. If you’re doing the same thing in your investment strategy, unhedged is for you.

Or, you may be the kind of investor who keeps up with global economics and think they have a leg up on the general investment community in figuring out which way the dollar is going relative to other currencies. In that case you’ll flip back and forth between hedged and unhedged as you see the currency currents flow.

Perhaps you own foreign investments, especially bonds, because you believe they will out-perform the U.S. market, but tracking and predicting currencies is not your thing. In that case a hedged fund makes sense.

And for the rest of you who think someone else should figure all this out (which likely is most of you), you want those funds that tactically hedge—meaning they hedge when they think it will do good and not hedge when they think it will harm the portfolio.

What you don’t want to do is look back at what would have worked best in the recent past and make your decision that way. You’ll likely change at exactly the worst time. 

This article was published under the title  Reasons vary for currency hedging in the Wichita Falls Times Record News on June 21, 2015.