This article contains general information only and does not constitute personal financial advice. Your circumstances are unique. Speak to a qualified adviser before making investment decisions.
If you’ve ever looked at a managed fund and seen the words “hedged” or “unhedged” and quietly wondered what the difference actually is, you’re not alone. It sounds more complicated than it is, but it has a very real effect on your investment returns.
Currency hedging is relevant to any Australian investor who holds international shares, global ETFs, or internationally diversified managed funds. And with international equities making up a significant portion of most modern portfolios, understanding how currency risk works, and what to do about it, is genuinely important.
Currency Hedging Explained in Plain English
When you invest in overseas assets (US shares, European property funds, or global infrastructure, for example), your money is effectively sitting in a foreign currency. If the Australian dollar rises against that currency while your money is invested there, the value of your investment in Australian dollar terms goes down, even if the underlying asset has actually grown in value.
Currency hedging is a strategy that locks in a fixed exchange rate for that foreign exposure, protecting your investment from adverse currency movements.
Think of it like this: imagine you buy a share of a US company for US$100 when the AUD/USD exchange rate is 0.70, meaning you paid roughly A$143. If the US share stays flat but the Australian dollar strengthens to 0.80, your investment is now worth only A$125 when you convert it back. That’s a loss of around 13%, purely from the currency shift, with nothing to do with how the company performed.
A hedged fund removes that variable by using financial instruments (typically forward contracts) to neutralise the currency exposure. An unhedged fund leaves it open.
Why Currency Movements Affect Your Investment Returns
The Australian dollar is notoriously volatile. It moves in response to iron ore prices, interest rate differentials, global risk sentiment, and whatever the US Federal Reserve happens to be signalling that week. For Australian investors, this creates a layer of unpredictability that sits on top of normal investment risk.
Currency risk in investing is often underappreciated, particularly during periods when the Australian dollar is relatively stable or falling. When the AUD falls, unhedged international investments actually benefit, because your foreign assets are worth more when translated back into local currency. This is why some investors actively prefer unhedged exposure: it can act as a natural buffer during periods of Australian economic weakness, when a falling dollar often coincides with falling local equity markets.
But the reverse is also true. When the Australian dollar is rising, typically when global confidence is high and commodity prices are strong, unhedged international holdings take a hit. If the AUD rallies 10% against the USD in a year, an unhedged international fund would need to generate more than 10% in capital growth just to break even in Australian dollar terms.
Over time, research in international finance, backed by the practical experience of most long-term investors, suggests that exchange rates tend to revert to the mean. The long-term impact of currency movements on a well-diversified portfolio is relatively modest. But that’s cold comfort if you’re drawing on your portfolio in retirement and a strong Australian dollar has just trimmed 8-12% off your international holdings.
Hedged vs Unhedged: What Australian Investors Need to Know
In Australia, most investors access international exposure through managed funds or ETFs. Many providers offer both hedged and unhedged versions of the same fund, which means the choice often sits directly with you (or your adviser).
The table below shows how they compare:
| Hedged | Unhedged | |
|---|---|---|
| Currency exposure | Neutralised | Open |
| Returns driven by | Underlying asset performance | Asset performance + AUD/foreign currency moves |
| Best conditions | AUD rising against major currencies | AUD falling or stable |
| Added cost | Yes (usually small) | No hedging cost |
| Complexity | Slightly higher | Simpler |
Asset class matters too. Currency movements typically represent a larger proportion of total return volatility in lower-volatility assets like global bonds or infrastructure. On a fixed income fund targeting 4-5% annual returns, a 5% currency swing is significant. On a high-growth equity fund targeting 8-10%, that same currency move is comparatively less impactful, which is why hedging is often prioritised for defensive assets before growth assets.
Three things to keep in mind:
Hedging is not free. Currency forward contracts have a cost, which is built into the fund’s management fee or reflected in the return differential. This cost is often cited in the range of 0.1-0.3% per year under normal market conditions, though it varies with interest rate differentials between countries and can move outside this range. It’s real, and it compounds over time.
Hedging is not perfect. Most fund managers hedge at the total fund level, not at the individual holding level. And hedging ratios aren’t always 100%. A fund might be 50% hedged or 75% hedged. Read the product disclosure statement (PDS) carefully.
It’s not an either/or decision. Many investors hold both hedged and unhedged international exposure, either through different funds or through funds that dynamically manage their hedge ratio. This blended approach reduces the risk of getting the currency call completely wrong in either direction.
When Currency Hedging Makes Sense, and When It Doesn’t
There’s no universal right answer here. The decision comes down to your circumstances, your time horizon, and what role international assets play in your overall portfolio.
Currency hedging tends to make more sense when:
- You’re in or approaching retirement. If you’re drawing income from your portfolio within the next 5-10 years, you have less time to ride out currency volatility. A 10% currency-driven loss hits differently when you’re drawing down, versus when you’re 30 years from needing the money.
- Your portfolio is heavily weighted to international assets. The more international exposure you have, the more significant the currency risk becomes. Hedging can reduce volatility at the total portfolio level.
- You’re investing in lower-volatility international assets. Fixed income and infrastructure have lower inherent volatility than equities, so currency movements represent a larger share of total risk. Hedging makes more sense here.
Currency hedging is less critical when:
- You have a long time horizon. If you’re a Subiaco professional in your 40s with a 20+ year investment runway, short-term currency fluctuations matter less. Unhedged exposure gives you more upside if the AUD softens.
- Your portfolio has meaningful Australian equity exposure. Australian shares and AUD tend to move together, both being correlated with commodity prices and global risk sentiment. If you’re already well-invested domestically, unhedged international assets can provide genuine diversification.
- You’re investing in highly volatile asset classes. For high-growth international equities, asset-level volatility is already high. Currency movements are noise by comparison.
If you hold international shares in a self-managed super fund (SMSF), currency risk may interact with your fund’s liquidity requirements and pension phase obligations in ways that warrant specific advice. This is worth working through with a financial adviser rather than applying a general rule.
How to Factor Currency Risk Into Your Overall Investment Strategy
Currency hedging is not a set-and-forget decision. It’s an ongoing part of portfolio construction that should be reviewed as your circumstances change.
There are five questions worth working through with your adviser:
1. What is your total currency exposure?
Look across your whole portfolio: super, personal investments, managed funds, ETFs. How much of your total exposure is in foreign currency? Many investors are surprised to find that their “Australian” superannuation fund holds 30-40% in international assets, often unhedged.
2. How does your hedging match your time horizon?
If you’re more than 15 years from drawing on a particular investment, currency risk is less critical and more likely to wash out. As you move closer to drawing on those funds, the case for hedging strengthens.
3. What is the hedging cost relative to the expected return?
A 0.2% hedging cost is meaningful if it’s being applied to a bond fund returning 4-5% per year. It’s less significant on an equity fund targeting 8-10% annual returns. Don’t hedge purely for the sake of it without understanding what you’re paying.
4. Are you trying to predict the AUD?
Nobody has a consistent edge predicting currency movements over the medium term. Not economists, not fund managers, not central banks. Build your hedging position based on your risk tolerance and time horizon, not a view that the AUD is “definitely going up” or “bound to fall.”
5. Does your current position reflect your actual situation?
The right hedged vs unhedged balance is different for a 58-year-old Nedlands couple entering retirement than it is for a 42-year-old professional in Applecross still accumulating wealth. A qualified financial adviser can model how currency risk sits within your overall investment strategy, including whether your current exposure aligns with your goals.
Once you understand what currency hedging is actually protecting against, the hedged vs unhedged decision becomes a lot clearer. Hedging reduces volatility but comes with a cost. Unhedged exposure offers more potential upside but more variability too. Neither is inherently better. The right answer depends on your goals, your timeline, and how much currency movement you can comfortably absorb.
If you’re unsure how much currency risk your portfolio currently carries, or whether your hedging position suits where you are in your financial life, talking to an adviser is a good starting point.
Talk to the Capital Partners team about your investment strategy
The information in this article is general in nature and does not constitute personal financial advice. You should consider your own financial circumstances before making investment decisions. Capital Partners Private Wealth Advisers holds an Australian Financial Services Licence.
