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Currency Risk

Currency Risk

💡Take Away

  • Anyone investing globally automatically invests in countries and companies with currencies other than the euro.

  • Currency pairs like EUR/USD can fluctuate, representing both a currency risk and an opportunity.

  • By diversifying globally and investing for the long term, investors balance out currency risks and opportunities, making it unnecessary to hedge against such fluctuations.

  • The fund currency of an ETF is purely cosmetic and does not represent either a risk or an opportunity—it is irrelevant.

What Role Does Currency Play in ETFs?

When you invest in companies outside the Eurozone through an ETF, you introduce various currencies into your portfolio—this comes with currency risk.

The fund currency, meaning the currency in which an ETF is listed, does not matter. A US dollar-denominated ETF carries the same currency risk as its euro-denominated counterpart if they track the same index.

World ETFs bring many different currencies into your portfolio

The major advantage of world ETFs is broad diversification: You automatically invest in different countries, continents, and therefore, various currencies. For example, the MSCI World includes companies like Apple (USD) and Nestlé (CHF), along with many other currencies.

This introduces both currency risk and currency opportunity into your portfolio.

  • Currency risk can slightly reduce your returns if exchange rates move unfavorably, and depending on your investment amount, it may have an impact. However, this risk shouldn’t keep you up at night.

As an investor, it’s essential to understand the role of different currencies in your investments. All securities within an ETF have a “home currency,” but companies are exposed to currency fluctuations as soon as they operate internationally. For example, Apple sells its products worldwide and generates revenue in multiple currencies. The same applies to other companies like Samsung or NestlĂ©. Globally operating companies can hedge against such currency risks.

Indirect Hedging Against Currency Risk

If you invest in the MSCI World, you have a portfolio with exposure to multiple currencies and a certain dependence on the US dollar. However, upon closer examination, many individual securities within the index are already highly diversified in terms of currency.

Currency Risk Is Also an Opportunity

What exactly is meant by currency risk? Whenever you invest in securities outside the Eurozone, you take on this risk. It refers to the possibility that your home currency—such as the euro in Germany and Austria—appreciates against the currency of your investment.

Example

Let’s say you own 100 shares of an ETF that tracks the U.S. Standard & Poor’s Index, such as the Vanguard S&P 500 UCITS ETF. If the U.S. dollar weakens against the euro, the value of each of your 100 shares decreases. If you were to sell at that point, you would incur a loss due to the unfavorable exchange rate movement.

However, the opposite scenario is also possible: If the U.S. dollar strengthens against the euro, your shares become more valuable in euro terms.

Fund Currency of an ETF

The fund currency of an ETF refers to the currency in which the fund’s assets are managed by the ETF provider. This is typically the same currency used in the index that the ETF tracks. You can usually recognize this in the ETF’s name or, at the latest, in the ETF’s factsheet.

  • However, for you as an investor, this is not relevant. Your broker settles in your home currency, which in Germany is the euro. The fund currency is essentially a marketing tool to suggest more security and does not protect you from currency risk đŸ€Ș.
Example
To convert the returns of a US-dollar-denominated ETF to euro, the rough calculation goes like this: US dollar return minus 2% = euro return. So, if a U.S. index rises by 5%, your German ETF would only show a 3% return, but in the end, the same amount of money will be received.
  • Different exchanges trade in different currencies, and the trading currency is indicated by the exchange. For example, on Xetra (Frankfurt) and Paris, the trading currency is always the euro, regardless of the fund currency. However, at the Zurich Exchange, trading occurs in Swiss francs.

Important: Don’t let this confuse you. It doesn’t matter whether you buy an MSCI World ETF in U.S. dollars or euros. It is essentially the SAME product. This is because your depositary bank will convert everything to euros anyway. The fund currency is not relevant to you as an investor.

Exchange Rates are Mathematically a Zero-sum Game

Overall, exchange rates have an expected return of 0% mathematically. This means that, in the long term, no profit is expected from exchange rates. The chance of losing money due to exchange rates is as high as the chance of making money.

How to Manage Exchange Rate Risk with Global ETFs

With ETFs, you have good opportunities to keep currency risk low. You can proceed as follows:

  • Split your assets across different asset classes and markets with different currencies.
  • Invest long-term: Over a longer period, currency fluctuations usually balance out.
  • Optionally: Increase the proportion of European companies in your portfolio. You can achieve this by adding an ETF on the MSCI Europe or Euro Stoxx 600.

In Most Cases Unnecessary: Currency Hedging with Hedged ETFs

If you want to hedge against exchange rate risk, you can use “hedged ETFs,” which protect your assets with other financial derivatives. However, these come with additional fees that can reduce your overall returns.

Hedged ETFs can only eliminate currency risk in the short term, not in the long term. If you’re planning to invest for the long term, we recommend against them. As mentioned, hedged ETFs reduce your returns and are only sensible for short-term speculation, if at all.

Reference