Currency hedging can be confusing for investors who use index funds and ETFs that hold foreign stocks or bonds.
The basic idea, which I have written about before, is not terribly hard to understand. If a Canadian buys an unhedged index fund that tracks US stocks, her returns will suffer if the US dollar declines against the loonie. (On the other hand, she’ll get a boost if the greenback appreciates.) If a fund uses currency hedging, however, you can expect the same return as the underlying stocks, regardless of the currency fluctuations.
But things get complicated when there is more than one foreign currency involved. The iShares MSCI EAFE Index Fund (XIN) covers more than 20 countries, and the stocks are denominated in British pounds, Japanese yen, euros, Swiss francs, Australian dollars and a few others. The hedging strategy is designed to eliminate the effect of fluctuations in all of these currencies compared with the loonie. So investors in XIN should expect the same return in Canadian dollars that local investors in Europe, Asia and Australia receive in their own currencies.
US funds rarely use hedging
I’m not sure why,