Hedging Currency Exposure

Currency hedging removes the exchange-rate part of a foreign investment’s return. It smooths the ride, but costs money and can backfire. Here is how hedged funds work and when hedging makes sense.

How a hedge works

A currency-hedged fund owns foreign stocks and also uses forward contracts to lock in exchange rates. If the foreign currency falls, the forward contracts gain, offsetting the loss. If the currency rises, the forwards lose, cancelling the gain. You are left with roughly the stocks’ local return.

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