Understanding currency risk and currency hedging

Claymore Investments, Inc. 15 May, 2010 | 4:59AM

One of the major additional risk considerations for global investing is the currency risk associated with the portfolio. When investing in global products, investors are buying securities domiciled in foreign currencies, and the fluctuations of these currencies can have an impact on a portfolio's performance.

For example, a Canadian investor can buy a Canadian-listed ETF that trades in Canadian dollars but that tracks a basket of global stocks. The portfolio's returns will then be made up of two parts: the returns from the basket of underlying stocks, plus or minus the returns from the currency exposure of the underlying stocks relative to the Canadian dollar.

More specifically, if the stocks return 10% but the Canadian dollar rises 4%, the investors will only return approximately 6% because the Canadian dollar appreciation will hurt the value of the stocks back in Canadian dollars. If the Canadian dollar drops 4%, the investor would benefit from the appreciation of the global currency against the Canadian dollar and earn 14% on that investment.

While some ETFs are exposed to the currency fluctuation of the underlying securities, other ETFs may have a currency hedging policy in place with the objective of reducing the fluctuations of currency in the investment, and simply provide the returns from the underlying market itself. As with any investment strategy, there is a risk that the hedge strategy used will be unsuccessful. The currency policy of the ETF will have an impact on the total performance of the fund, so it's important for investors to know the currency policy of the investment products they select.

Using the same example as before -- now with a currency-hedged ETF, if the underlying stocks earned 10%, the ETF would aim to return 10% by trying to hedge away what the currency of the underlying stocks did because the plus or minus 4% currency fluctuation would be reduced or nullified with the hedge.

Claymore offers both currency-hedged and non-hedged ETFs focused on global, international and emerging markets, along with a number of global sector options. When diversifying outside of Canada, we hope you'll consider Claymore ETFs for your global and international needs.

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Claymore Investments, Inc.

Claymore Investments, Inc.