Currency risk
With foreign investments, the currency fluctuates alongside the price. What matters is the currency of the underlying holdings, not the fund's trading currency.
Buy an ETF on US stocks, and you're making two bets at once: on the stocks and on the dollar. If the stocks rise ten percent and the dollar falls ten percent, you've gained roughly nothing in euros.
A common misconception: if the ETF is listed and traded in euros, the currency risk hasn't gone away. What matters is the currency the underlying companies do business in, not the currency you buy the security in.
Currency-hedged versions exist. They largely remove the currency swing, but cost money continuously, roughly in line with the interest-rate gap between the two currencies.
For long-term stock holdings, most people don't hedge. Currency swings tend to partly offset over very long periods, and hedging costs are certain while the benefit is uncertain. For bonds the trade-off is different, since currency swings there can easily swamp the underlying return.
The return on a foreign-currency investment in your home currency follows from (1 + r_local)(1 + r_currency) − 1. For small moves, the cross term is negligible, so the approximation r_local + r_currency is usually good enough. Total return variance also depends on the correlation between the price and currency moves, which isn't stable and often flips sign during crises.
For broadly diversified stock funds, the relevant currency exposure isn't the listing currency, nor even just the trading currency of the holdings, it's the economic exposure of the underlying, internationally active companies. A company with global sales already carries a mixed currency structure itself, which means the actual exposure of a global stock fund is less concentrated than a breakdown by listing currency suggests.
The cost of currency hedging roughly corresponds to the interest-rate gap between the currencies involved, since hedging runs through futures contracts priced via covered interest-rate parity. With a substantial rate gap, this cost can become significant and, over long periods, eat into the diversification benefit.
Summary
- An ETF's listing currency tells you nothing about its currency risk.
- Hedging costs roughly the interest-rate gap, continuously.
- Few hedge with stocks; the trade-off is different for bonds.
Did you get it?
Does currency risk disappear if an ETF is listed in euros?
No. What matters is the economic exposure of the underlying companies, not the listing currency.
What does currency hedging roughly cost?
Roughly the interest-rate gap between the currencies involved, continuously.
Why is the trade-off different for bonds than for stocks?
Because currency swings there can easily swamp the comparatively small underlying return.
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