In which currency should I buy ETFs?
Key Takeaways
- ETF currencies may seem confusing at first. It may seem intuitive to look for ETFs in your home currency. But this is not always the best choice.
- There are four currency types when looking at an ETF (i) the underlying assets’ currencies (ii) the hedging currency (iii) the trading currency and (iv) the Fund base currency.
- However, only the first two of them are really important. Make sure you understand the currencies you will be exposed to and hedge, if needed. If available (but this is optional) try to buy a share class denominated in your home currency.
- A single ETF, like the Vanguard FTSE All-World UCITS ETF can have multiple ETF share classes to suit different investor preferences (for example with respect to currency hedging or dividend distribution policy).
- The underlying assets’ currencies and the fund base currency are valid at Fund level (e.g. all share classes have the same underlying assets’ currencies).
- However, a trading currency and currency hedging is specific to the share class you invest in.
Which Currencies are important?
Relative Importance of the four currency types in an ETF
Where can I find the four currency types?
- The Underlying currencies are usually to be found in the ETF Factsheet. A breakdown by currencies (or sometimes only countries) can give you a rough idea what currencies you will be exposed to.
- The Hedged (to) Currency can be found in the description of the share class. This one is hard to miss because when you look up the share class the description will state it clearly e.g. “iShares Core MSCI World UCITS ETF EUR Hedged (Dist)”
- The Trading currency will be available when you look up the share class with your broker, in the factsheet or ETF provider description page
- Finally, the Fund Base Currency is also available either in the factsheet or ETF provider ETF description
Underlying Currencies
The importance of currency risk in an ETF
The Underlying Assets’ currencies have a major impact on the ETF’s return.
It is the most important currency set to consider when investing in an Index Fund, since you will be exposed to the fluctuation of the underlying currencies versus your own home currency.
The currencies of underlying Stocks in an Equity ETF may not be the true currency risk you are taking
The ETF currency risk you are taking is more complex than just looking at the currencies of the underlying ETF Stocks.
While equities are denominated in a certain currency in which they trade on a Stock Exchange, they also may have business models relying on global sales.
For example, close to 60% of Equity Market Capitalization in MSCI ACWI Index is denominated in USD. However, only around 30% of all revenues from the same Index come from North America.
Some companies may or may not choose to hedge foreign currency risk depending on industry standards and competition.
The currencies of underlying Bonds in a Bond ETF is the true currency risk you are taking
Example of currency exposure for a Global Developed Government Bond ETF
The underlying Bond currency is the true currency risk you are taking in a Bond ETF. For example, the Xtrackers Global Developed Government ETF invests in Developed World Government Bonds and the major countries for those Indices and ETFs are USA, Japan and France.
For each of the underlying Bonds currencies are primarily the USD, JPY and EUR but also other countries with lower exposure in the ETF.
You will be exposed to fluctuations of those currencies, unless you decide to hedge.
Do the Underlying assets' currencies apply at ETF Fund level or share class level?
The Underlying Assets currency applies at the overall Fund level.
Currency HEDGING
Hedging is key to ETF currency returns
The ETF share class currency hedge is a very important driver of ETF returns.
Outside of Underlying Assets’ Currencies this is the second most important currency aspect to pay attention to.
Hedging may not always remove all currency risk
Hedging currencies, by investing a hedged ETF share class will remove currency risk for Bond ETFs. For example, if you are a European Investor and choose the EUR Hedged Class you will be earning income in EUR from International Bonds without taking any currency risk. If you hedge the currency, the asset currency performance risk becomes largely irrelevant.
Hedging currency risk does not protect you from all currency risk in Equity ETFs. The companies you invest in have international operations and may not choose to hedge foreign currency risk, in which case you will be still indirectly exposed to it.
What is the impact of currency hedging on ETF Returns?
Hedging can have a major impact on performance (example of difference in return for UK Investor holding a S&P 500 ETF)
Currency hedging can have a major impact on overall ETF returns. It is not always beneficial.
As illustrated above, the difference in return can be substantial. Here the annual return can vary as much as 25% depending on your choice of ETF currency hedging.
Should I buy a currency hedged ETF share class?
ETF currency hedging decision matrix
It depends on your time horizon and whether it’s related to Equities or Fixed Income.
In summary, given that an investor chooses Bonds to reduce the volaility of the portfolio, the currencies for Bond ETFs should be hedged.
For Equities, currencies have low impact in the long run but may be hedged in the short run depending on your risk tolerance.
Another aspect to remember is that you can’t fully hedge all the underlying currency risks in an Equity ETF, since the hedged ETF share class only hedges the currencies in which the underlying shares trade.
These share classes do not hedge the currency risk that the companies are taking, for example for companies with global sales.
For more detailed explanation, please consult a separate guide dedicated to currency hedging decision.
Does currency hedging apply at ETF Fund level or share class level?
Currency hedging applies at the ETF Class level. As a European Investor, in most cases you will have the option to hedge the underlying currencies – as of September 2020, there are over 550 currency hedged ETFs in Europe.
SHARE CLASS TRADING Currency
The ETF share class currency shouldn't be your first focus
Relative number of European ETF classes listed in major Trading currencies
The ETF share class currency is not a key aspect in ETF selection and will not have an influence on the returns.
It’s better to choose a share class from an ETF that will fulfil all key selection criteria – e.g. correct benchmark or right tax domicile and is denominated in a foreign currency than prioritizing a share class in your home currency
However, if all other criteria are fulfiled, it may be marginally beneficial if the trading currency is your home currency. But remember, it’s not mandatory if you don’t have that option.
The reason is that you pay an additional (usually small) exchange rate conversion fee at the time of purchase and sale if you don’t buy in your own currency. There is ample choice in European currencies for major ETFs so you will probably have the option to use your own currency as Trading currency.
Does the ETF Share class currency expose me to additional currency risk?
The ETF Share class currency does not change the currency risk you are taking by investing in the underlying assets and thus, this currency also doesn’t have any influence on the overall ETF performance.
You are not holding or exposed to this currency in any way. At purchase you exchange your own currency to buy the ETF Trading currency (in order to buy the Fund) which gets exchanged against the Fund Base Currency. However, ultimately the Fund buys the underlying Assets so all the intermediary currencies don’t matter much.
The opposite happens when you sell.
Does the Trading currency apply at ETF Fund level or share class level?
The Trading Currency applies at the ETF Class level.
Is it the currency listed on the Exchange in which the ETF is quoted with your Broker. It’s also usually (depending on the broker) the currency you will see in your broker account when you look at your holding.
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Beginners often ask us:
- How do I reach my goals – What investments do I need to take into consideration when e.g. Taking a Sabbatical, buying a House or saving for Early Retirement?
- When should I invest – I fear that investing a lump sum in this market may have a negative impact on my returns. How can timing of buying ETFs affect my performance?
Advanced investors may avoid costly mistakes:
- Challenge my Portfolio – Here is my portfolio – what am I missing? What could derail my strategy? What can I do to protect my portfolio from shocks?
- Help me quickly understand – What makes Inflation Linked Bonds outperform? Bond Ladder or Bond ETFs? Why do some investors add Small Cap Value stocks to their portfolios? How can I exclude Tobacco companies from my portfolio? Are the synthetic ETFs I screened safe? What is Factor Investing?
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Fund BASE Currency
ETF Base currency is mainly for reporting purposes
The fund base currency has marginal importance in ETF selection and will not have an influence on the returns from the ETF.
Note that for distributing funds dividends are distributed in the fund currency. Your broker will convert the distributed amount into your currency for an additional conversion fee.
Does the Fund Base currency expose me to additional currency risk?
The Fund Base Currency simply refers to the currency that a fund reports in and not the currencies of the underlying securities which you are exposed to.
For example, for a Global Government Bond ETF, the Fund will have classes in different currencies and some are distributing dividends while others are reinvesting them there are various available options for investors.
However, the Fund Manager must consolidate all information and will report in a unified way (usually using the benchmark currency as reference).
Usually everything is reported in EUR or GPB (but for a large proportion of Global funds this currency is USD and that shouldn’t stop you in any way, as European Investor, from choosing such Fund)
Does the Fund Base currency apply at ETF Fund level or share class level?
The Fund Base Currency applies at the overall Fund level.
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