Exchange Rate Effect6 分钟阅读

Currency Hedging Costs Money

Currency hedging 'fixes' the exchange rate so you don't have to worry whether the dollar rises or falls—it seems safe, right? But what if this safety device is quietly eating away at your money every year?

What is currency hedging

When you invest in overseas stocks or ETFs, two things move at once. One is the price of the stock itself, the other is the exchange rate. For example, even if a U.S. stock rises 10%, if the won-dollar rate falls 10% in the meantime (won strength), your won return in your account could end up close to zero.

Currency hedging is a device that 'eliminates' the impact of this exchange-rate movement. It usually locks in the future exchange rate in advance through futures/forward contracts, so that only the stock's own return—regardless of whether the exchange rate rises or falls—is reflected in your account. An (H) after an ETF's name means hedged, while (UH) or no marking means currency-exposed (unhedged).

Currency hedging blocks the 'risk of losing money to exchange rates,' but it is at the same time a trade that gives up the 'chance to profit from exchange rates.'

Why it costs: the interest-rate difference between two countries

The core principle of currency hedging is explained by a formula called 'covered interest rate parity.' Put simply, the value that locks in the future exchange rate in advance (the forward rate) diverges from the current exchange rate (the spot rate) by as much as the interest-rate difference between the two countries.

As a formula it is expressed as forward rate = spot rate × (1 + domestic rate) ÷ (1 + foreign rate). As a result, the currency-hedging cost ends up roughly equal to 'the interest-rate difference between the two countries.'

Intuitively, think of it this way. If the interest rate on the dollar you want to hedge is higher than the won rate, you are effectively giving up the higher-interest dollar and locking in your result in the lower-interest won. That interest difference leaks out as a cost each year. Conversely, if the dollar rate is lower than the won rate, the hedging cost can actually go negative and be a slight gain.

In other words, the currency-hedging cost is less a fee someone sets and takes, and closer to an 'opportunity cost' that arises naturally from the interest-rate difference between the two currencies.

How much does it actually cost

Generally, the hedging cost of currency-hedged funds and ETFs is known to be around 0.5–2% per year. On top of that, the difference in ETF total expenses adds up too. For example, a certain U.S. S&P 500 ETF listed in Korea has a currency-exposed total expense of 0.11% per year while the hedged version is 0.25%, making it 0.14 percentage points more expensive just in fees. On top of this, the interest-rate-difference cost explained above is added separately.

A representative case is the 2022–2023 Korea-U.S. rate-inversion period. As the U.S. rapidly raised its benchmark rate, at one point it became about 2 percentage points higher than Korea, and according to a Korea Capital Market Institute analysis, the won-dollar swap rate during this period fell to around -2%, the lowest since the global financial crisis. As a result, for an institution to maintain a currency hedge, the structure required continually bearing a cost of about 1.5–2% per year (150–200bp). There were reports that some products' hedging cost alone reached the high 2% range per year.

Hedging costs continually change with market supply and demand. The figures above are cases from a specific period, not values that predict future costs or the direction of exchange rates.

Hedged vs currency-exposed, which is the right answer

To put the conclusion first, there is no 'always-correct answer.' The two choices simply bear different risks.

The currency-exposed type takes the exchange-rate swings as-is. If the won weakens (rate rises), returns grow, but if the won strengthens, returns are shaved off. The currency-hedged type removes this swing but pays the hedging cost seen above every year and gives up the opportunity of a rising exchange rate.

Especially when holding an asset that has trended upward for a long time, like U.S. stocks, for a very long time, the hedging cost that leaks out each year can pile up through compounding and noticeably eat into long-term returns. Conversely, if your investment period is short or sudden exchange-rate swings feel burdensome, the 'predictability' of the hedged type can help psychologically. Either way, the key is to choose while knowing that hedging is not a 'free safety device' but 'stability you buy by paying a cost.'

'The Return of Almost Everything' shows the exchange-rate effect separated out, without hiding it. For the same asset, you can directly compare how different the return is with and without the exchange rate reflected.

常见问题

Q. Do you always lose money if you hedge currency?

No. When the interest rate on the currency you want to hedge (e.g., the dollar) is higher than the won, it costs money; but conversely, in a phase where the won rate is higher, the hedging cost can actually go negative and become a slight gain. Also, if the exchange rate moved sharply against you, the hedge that blocked that loss can turn out to be helpful. Whether it's favorable or not is decided by the 'interest-rate relationship' and 'the direction of the exchange rate during that period.'

Q. Where is the currency-hedging cost shown?

Rather than being billed as a separate line item, a fund's or ETF's hedging cost is mostly blended into the NAV (price) and quietly reflected. So it's hard for investors to feel it. Comparing the long-term return charts of the hedged and currency-exposed versions side by side lets you faintly see the cost hidden in the difference.

Q. For long-term investing, is the hedged or currency-exposed type better?

There is no right answer. But you should consider together that over a very long period the hedging cost that leaves each year accumulates through compounding, and that exchange rates can rise or fall greatly over the long run. This page does not recommend any specific product; it is an explanation to help you understand the nature of the two choices and judge for yourself.