Why hedging is important

Claymore Investments, Inc. 15 May, 2010 | 5:00AM

Currency hedging refers to the ability to reduce or eliminate the effect of currency fluctuations on the performance of a global portfolio. ETFs focused on global or international securities may be unhedged, in which case the returns of the underlying portfolio will be affected by the currency of the underlying securities -- or it may be hedged, in which case the returns of the ETF will only be affected by the returns of the underlying holdings, and any fluctuation in the currency will be reduced or eliminated.

Currency hedging is generally implemented by using forward currency contracts, which aim to offset the effect of the currency fluctuations associated with the portfolio. Because the implementation of a currency hedge has a cost associated with it – which is typically the spread between the interest rates of the domestic country and the countries whose currency is being hedged -- the value of the hedge must be weighed against the costs.

Over long periods of time, currency fluctuations tend to revert to their long-term averages, but short-term variations may still have a significant impact on global portfolios' short-term returns. With the number of ETFs growing each year, investors have the choice of whether a hedged or unhedged product is most advantageous.

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Claymore Investments, Inc.

Claymore Investments, Inc.