Hedged vs Unhedged ETFs: Which Is Better for Australians?

One of the most fundamental decisions Australian investors face when selecting international ETFs is whether to choose hedged or unhedged currency exposure. This choice affects returns, volatility, and portfolio behaviour in ways that many investors don't fully understand.

This educational guide explains currency hedging in ETFs, examines the differences using real ASX examples, and provides a framework for considering which approach may suit different investment situations.

Hedged vs unhedged ETF comparison infographic showing VGS, VGAD, IVV, and IHVV with currency exposure differences, fees, and $10,000 investment examples for Australian investors

What Is Currency Hedging?

Currency hedging is a financial strategy that removes or reduces the impact of exchange rate movements on investment returns. When Australian investors purchase international ETFs, the underlying assets are typically denominated in foreign currencies (predominantly US dollars, but also euros, yen, and others).

Without hedging, two factors affect returns:

1. Asset performance: How the underlying shares perform in their local currency

2. Currency movements: How the Australian dollar moves against the foreign currencies

Hedged ETFs use financial instruments (typically currency forward contracts) to eliminate the second factor, leaving only the asset performance to determine returns in AUD terms.

Hedged vs Unhedged: The Key Difference

Unhedged ETFs

Unhedged ETFs maintain full exposure to both the underlying assets and currency movements. When the Australian dollar weakens against the foreign currencies, unhedged ETF returns increase in AUD terms. Conversely, when the AUD strengthens, returns decrease.

Example ETFs:

• VGS (Vanguard MSCI Index International Shares ETF) - 0.18% management fee

• IVV (iShares S&P 500 ETF) - 0.04% management fee

Hedged ETFs

Hedged ETFs remove currency impact by using derivatives to lock in exchange rates. Investors receive the underlying asset returns in their home currency (AUD) without currency fluctuation effects.

Example ETFs:

• VGAD (Vanguard MSCI Index International Shares Hedged ETF) - 0.21% management fee

• IHVV (iShares S&P 500 AUD Hedged ETF) - 0.10% management fee

Real Example: VGS vs VGAD

Both VGS and VGAD track the MSCI World ex-Australia Index with approximately 1,500 international companies. The only difference is currency treatment.

VGS (Unhedged)

• Management Fee: 0.18% per annum

• Currency Exposure: Full exposure to foreign currencies (primarily USD ~74%, EUR ~10%, JPY ~6%, GBP ~4%)

• Returns: Reflect both underlying share performance AND currency movements

• Volatility: Generally higher due to currency fluctuations

VGAD (Hedged)

• Management Fee: 0.21% per annum (0.03% higher than VGS)

• Currency Exposure: Hedged to AUD (currency movements removed)

• Returns: Reflect only underlying share performance

• Volatility: Generally lower in AUD terms (no currency volatility)

The 0.03% fee difference represents the approximate cost of maintaining currency hedges.

Real Example: IVV vs IHVV

IVV and IHVV both track the S&P 500 Index, providing exposure to 500 large US companies. Again, currency treatment is the distinguishing factor.

IVV (Unhedged)

• Management Fee: 0.04% per annum

• Currency Exposure: Full USD exposure

• Returns: US share performance PLUS AUD/USD movements

• Suitability: Investors comfortable with currency risk

IHVV (Hedged)

• Management Fee: 0.10% per annum (0.06% higher than IVV)

• Currency Exposure: Hedged to AUD

• Returns: US share performance only (currency neutralised)

• Suitability: Investors wanting pure equity exposure

The 0.06% fee difference covers hedging costs for removing USD currency exposure.

Practical Example: $10,000 Investment Scenario

To illustrate how currency movements affect returns, consider a $10,000 investment in international shares over one year.

Scenario 1: AUD Weakens 10%

Assumptions:

• Underlying international shares gain 8% in local currency

• AUD falls from 0.70 USD to 0.63 USD (10% decline)

Unhedged ETF (VGS or IVV):

• Share performance: +8%

• Currency benefit: +10% (AUD weakened, making foreign assets worth more in AUD)

• Total return: +18.8% (compound effect: 1.08 × 1.10 = 1.188)

• Ending value: $11,880

Hedged ETF (VGAD or IHVV):

• Share performance: +8%

• Currency impact: 0% (hedged)

• Total return: +8%

• Ending value: $10,800

In this scenario, the unhedged ETF outperforms by $1,080 because the weakening AUD boosted returns.

Scenario 2: AUD Strengthens 10%

Assumptions:

• Underlying international shares gain 8% in local currency

• AUD rises from 0.70 USD to 0.77 USD (10% increase)

Unhedged ETF (VGS or IVV):

• Share performance: +8%

• Currency drag: -10% (AUD strengthened, making foreign assets worth less in AUD)

• Total return: -2.8% (compound effect: 1.08 × 0.90 = 0.972)

• Ending value: $9,720

Hedged ETF (VGAD or IHVV):

• Share performance: +8%

• Currency impact: 0% (hedged)

• Total return: +8%

• Ending value: $10,800

In this scenario, the hedged ETF outperforms by $1,080 because currency movements were eliminated.

Key Insight

Neither approach is inherently superior. Unhedged ETFs benefit when the AUD weakens but suffer when it strengthens. Hedged ETFs provide stable, predictable exposure to underlying asset performance regardless of currency movements.

Historical Currency Patterns

The Australian dollar has experienced significant volatility against major currencies over the past decades:

Long-Term AUD/USD Trends

• 2008-2011: AUD strengthened from 0.60 to 1.10 (favouring hedged)

• 2011-2016: AUD weakened from 1.10 to 0.70 (favouring unhedged)

• 2016-2021: AUD fluctuated 0.70-0.80 (mixed outcomes)

• 2021-2026: AUD ranged 0.62-0.72 (continued volatility)

Historical data shows the AUD typically trades in multi-year cycles, making short-term currency prediction difficult. Over very long periods (20+ years), currency effects tend to average out, though significant variation occurs in shorter timeframes.

Cost Comparison

Hedging comes with costs reflected in higher management fees:

ETF Pair	Unhedged Fee	Hedged Fee	Hedging Cost
VGS / VGAD	0.18%	0.21%	0.03%
IVV / IHVV	0.04%	0.10%	0.06%
NDQ / HNDQ	0.48%	0.51%	0.03%

Over 20 years, these cost differences compound:

• 0.03% extra (VGS/VGAD): ~$660 on $10,000

• 0.06% extra (IVV/IHVV): ~$1,320 on $10,000

These costs must be weighed against the value of removing currency volatility.

Volatility Considerations

Unhedged ETFs: Higher Volatility

Unhedged international ETFs typically show higher volatility than hedged equivalents because they combine:

1. Equity market volatility

2. Currency volatility

During market stress, currencies and equities sometimes move in opposite directions, occasionally reducing overall volatility. However, they can also move together, amplifying volatility.

Hedged ETFs: Lower Volatility

Hedged ETFs generally exhibit lower volatility in AUD terms because currency fluctuations are removed. This can make portfolio behaviour more predictable and reduce emotional decision-making during volatile periods.

For investors with specific AUD-denominated liabilities (mortgages, retirement expenses), hedged ETFs may provide better alignment with financial obligations.

Tax Implications

Both hedged and unhedged ETFs generate similar tax obligations:

Distributions

• Both receive foreign dividends (subject to foreign withholding tax)

• Both distribute income to Australian investors (taxable in AUD)

• Foreign tax credits apply to both

Capital Gains

• Both generate capital gains on sale

• Hedged ETFs may generate additional gains/losses from hedging contracts (already reflected in unit price)

• CGT discount available for both if held 12+ months

Foreign Currency Gains

Interestingly, unhedged ETFs held in personal names may trigger additional CGT if currency gains exceed $250 annually. This complexity is rarely material for most investors but exists in tax law.

Decision Framework: Factors to Consider

Rather than declaring one approach "better," investors can evaluate personal circumstances against these factors:

Consider Hedged ETFs When:

1. Comfort with predictability: Prefer consistent exposure to underlying assets without currency surprises

2. AUD-denominated liabilities: Have mortgages, expenses, or planned spending in AUD

3. Risk aversion: Want to reduce portfolio volatility

4. Short to medium timeframes: Investing for 5-15 years where currency movements significantly impact outcomes

5. Belief in AUD strength: Expect AUD to strengthen against foreign currencies

Consider Unhedged ETFs When:

1. Long-term horizon: Investing for 20+ years where currency effects may average out

2. Diversification preference: Value currency diversification as additional portfolio diversification

3. Lower costs preferred: Want to avoid paying hedging costs

4. AUD weakness expected: Believe AUD will weaken (providing currency tailwind)

5. Simplicity valued: Prefer straightforward exposure without derivative contracts

Consider Split Approach When:

Some investors hold both hedged and unhedged ETFs, effectively creating partial hedging:

• 50% VGS + 50% VGAD = 50% currency hedge

• 70% IVV + 30% IHVV = 30% currency hedge

This compromise approach reduces decision pressure and averages outcomes across currency scenarios.

Common Misconceptions About Hedging

Misconception 1: "Hedging is always more conservative"

Reality: Hedging removes currency diversification, which can sometimes reduce portfolio diversification. During AUD weakness, unhedged ETFs provide protection.

Misconception 2: "Hedged ETFs always have lower returns"

Reality: Returns depend on currency movements. Hedged ETFs outperform when AUD strengthens; unhedged outperform when AUD weakens.

Misconception 3: "Hedging costs are high"

Reality: Typical hedging costs range 0.03-0.06% annually—modest compared to currency volatility which can exceed 10% annually.

Misconception 4: "Long-term investors should never hedge"

Reality: While currency effects may average over very long periods, investors with AUD liabilities or shorter segments within long timeframes may still benefit from hedging.

Misconception 5: "You can time currency movements"

Reality: Currency forecasting is notoriously difficult. Even professional economists struggle to predict exchange rate movements consistently.

Practical Implementation Strategies

Strategy 1: Age-Based Hedging

• Accumulation phase (20-50 years old): Favour unhedged for long-term growth and diversification

• Pre-retirement (50-65 years old): Gradually increase hedged allocation

• Retirement (65+ years old): Favour hedged to match AUD spending needs

Strategy 2: Liability Matching

Match currency exposure to spending currency:

• Planning AUD retirement in Australia → Favour hedged

• Planning USD spending (expat lifestyle) → Favour unhedged

• Flexible international lifestyle → Mix or favour unhedged

Strategy 3: Core-Satellite

• Core (70-80%): Unhedged for diversification and lower costs

• Satellite (20-30%): Hedged for stability and tactical positioning

Strategy 4: Passive Hybrid

Hold equal weights of hedged and unhedged versions:

• Removes need to predict currency movements

• Averages outcomes regardless of AUD direction

• Simplifies decision-making

When to Review the Hedging Decision

Portfolio hedging strategy should be reviewed when:

1. Life circumstances change: Career transition, relocation, retirement approaching

2. Liability currency changes: Taking on AUD mortgage, planning overseas move

3. Time horizon shifts: Moving from accumulation to drawdown phase

4. Extreme currency movements: AUD moves significantly outside historical ranges

5. Cost changes: ETF fees or hedging costs materially change

Regular annual reviews ensure hedging strategy remains aligned with circumstances rather than being set-and-forgotten.

Academic Research Findings

Academic research on currency hedging presents mixed conclusions:

• Vanguard research: Suggests 50% hedging ratio may optimise risk-adjusted returns for Australian investors

• Dimensional Fund Advisors: Finds hedging benefits depend on base currency and investment horizon

• RBA studies: Note AUD tends to weaken during global market stress, providing natural portfolio protection when unhedged

No consensus exists, reinforcing that personal circumstances matter more than universal prescriptions.

Summary: No Universal Answer

The hedged vs unhedged decision depends entirely on individual circumstances rather than one approach being objectively superior. Key considerations include:

• Time horizon: Longer timeframes reduce currency impact importance

• Spending currency: AUD liabilities favour hedged exposure

• Risk tolerance: Higher volatility tolerance suits unhedged

• Cost sensitivity: Lower fees available with unhedged

• Currency views: Beliefs about AUD direction (though hard to predict)

Many successful investors use hybrid approaches, holding both hedged and unhedged ETFs to average outcomes regardless of currency movements.

The examples of VGS/VGAD and IVV/IHVV demonstrate that both approaches track identical underlying assets with only currency treatment differing. Neither approach guarantees superior returns—outcomes depend on unpredictable currency movements.

Further Research Resources

Investors seeking to understand currency hedging more deeply should:

1. Read ETF PDSs: Product Disclosure Statements explain specific hedging methodologies

2. Review provider research: Vanguard, BlackRock, and BetaShares publish hedging research

3. Consult fund fact sheets: Shows exact hedging ratios and costs

4. Consider professional advice: Licensed advisers can assess individual circumstances

5. Monitor currency trends: RBA and financial news provide AUD analysis

Data Sources: Vanguard Australia, BlackRock Australia, ASX ETF database (January 2026) Disclaimer: Finer Market Points Pty Ltd, CAR 1304002, AFSL 526688, ABN 87 645 284 680. This general information is educational only and not financial advice, recommendation, forecast or solicitation. Consider your objectives, financial situation and needs before acting. Seek appropriate professional advice. We accept no liability for any loss or damages arising from use.