When it comes to investing in international markets, Canadian investors are often faced with the issue of currency risk. Currency risk refers to the fluctuation of exchange rates between currencies, which can significantly impact investment returns. In this article, we’ll examine the pros and cons Hedged vs Unhedged ETF in Canada.
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Currency-hedged funds use hedging strategies to mitigate the impact of currency risk on returns. The idea is to protect investors against adverse exchange rate fluctuations by using futures, options or other financial derivative instruments to offset potential losses.
The advantages and disadvantages of hedge funds
Currency risk minimization
By hedging currency risk, Canadian investors can avoid potential losses caused by exchange rate volatility. This preserves the value of their investments and avoids adverse effects on returns.
Hedged funds offer some stability in terms of returns as exchange rate fluctuations are smoothed out. This can be especially important for investors with short-term goals or looking for some security in their investments.
Ease of management
Hedged funds are generally professionally managed, so investors do not have to monitor hedging strategies actively. This can be advantageous for investors who prefer a more passive approach.
Funds hedged against currency risk often have additional costs related to the hedging strategies in place. These costs can reduce net returns to investors (higher Management Expense Ratio).
Potential loss of earnings
By protecting against adverse exchange rate movements, hedged funds can also limit potential gains when the foreign currency strengthens against the Canadian dollar. Investors may miss opportunities to benefit from foreign currency appreciation.
Funds not covered
These funds do not use currency hedging strategies. Investors who opt for unhedged funds accept currency risk and are exposed to fluctuations in exchange rates.
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The pros and cons of NON-hedged funds
Higher earning opportunities
Unhedged funds do not seek to mitigate currency risk. So they can potentially benefit from favorable fluctuations in exchange rates. Investors may realize additional gains if the foreign currency in which the investment is denominated strengthens against the Canadian dollar.
Fluctuations in exchange rates can significantly impact the returns of investments denominated in a foreign currency. If the foreign currency depreciates against the Canadian dollar, investors may suffer losses in value and lower returns.
Unhedged funds are often more volatile due to their direct exposure to currency risk. Fluctuations in exchange rates may cause significant movements in the value of foreign assets held in the fund. Therefore, investors should be prepared to accept some volatility in their investments and have an appropriate risk tolerance.
This article examined the pros and cons of currency-hedged and unhedged funds for Canadian investors. Hedged funds offer minimization of currency risk, predictability of returns and ease of management through the use of professional hedging strategies. However, these funds incur additional costs and may limit potential gains in the event of foreign currency appreciation.
On the other hand, unhedged funds offer higher opportunities for gains in the event of foreign currency appreciation. Still, they expose investors to a greater risk of downside losses and increased volatility due to direct exposure. Exchange risk.