Currency hedging mitigates the additional volatility that exchange rates impose on foreign assets. But these currency-hedged strategies bear additional costs and can have tax implications. Our recent research paper, "The Currency-Hedging Dilemma,"addresses these various considerations. It reviews the fundamentals of currency hedging, explores the extra costs, and outlines a framework that investors can use to aid in their decision to choose a currency hedged fund.
The Nature of Currency Risk
When investors purchase a foreign investment, they must first convert their home currency to foreign currency. Thus, after completing a transaction, they are exposed not only to the risks of the foreign asset, but also to changes in the value of the foreign currency. This increases overall risk, and these two risks aren’t simply additive.
Daniel Sotiroff has a position in the following securities mentioned above: EWJ. Find out about Morningstar's editorial policies.