Pros and cons of currency hedging

Exchange rates can improve or reduce investment returns when you convert them back into your home currency. Using a currency hedge on your international investments can limit these fluctuations.

The good thing about hedging is it reduces any drop in your in-pocket returns that would result from converting the currency. The downside is you sacrifice the bonus that would be added onto your returns in cases where currency conversion rates are in your favour.

Once you decide if hedging is right for you, determine whether to do it with your stock or bond investments by buying the currency-hedged version.

Currency fluctuations are more problematic for bonds because their return rates are fixed. By adding a currency fluctuation, it can make an otherwise stable investment significantly volatile.

Some equities, on the other hand, already have high volatility. And that means adding some volatility by introducing a currency hedge will make less of a difference.

Overall, hedging currency risk has much greater impact on bonds than stocks. But, if foreign bonds represent a small percentage of your portfolio, the cost of hedging may outweigh any benefit.

Hedging costs can include compensating currency dealers for facilitating hedging transactions, paying custodian banks for record keeping, and fees to investment managers who are maintaining the hedge.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.