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International stock returns have two moving parts for an investor: the share market’s performance in its local currency and the change in the exchange rate between that currency and the investor’s home currency. A foreign market can rise while the investor’s account value falls if the home currency strengthens enough. The reverse is also true: a weaker home currency can magnify a foreign-market gain or cushion a local-market loss.
Currency hedging can reduce that exchange-rate effect, but it changes the exposure rather than guaranteeing a better result. The appropriate choice depends on the investor’s base currency, the markets held, the hedge ratio, the measurement period, the objective and the cost of implementation.
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What an international stock return actually measures
A local-market index reports what happened to securities in the market where they trade, using that market’s currency. An investor normally measures wealth in a different currency. Translating the investment creates a second return stream.
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A useful approximation is:
home-currency return = (1 + local equity return) × (1 + currency return) − 1
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Here, the currency return is positive when the foreign currency appreciates against the investor’s home currency. For a US-dollar investor holding euro-denominated shares, the euro’s rise against the dollar helps the translated result; the euro’s fall hurts it.
| Component | What it means | Question to ask |
|---|---|---|
| Local equity return | Change in the shares or index measured in the market’s own currency | Did the foreign companies gain or lose value locally? |
| Currency return | Change in the exchange rate between the foreign currency and the investor’s base currency | Did the foreign currency strengthen or weaken relative to my measuring currency? |
| Home-currency return | The result after translating the investment into the investor’s base currency | What happened to my actual account value? |
The multiplication matters. A 10% local gain and a 5% foreign-currency decline do not produce exactly a 5% home-currency gain: 1.10 × 0.95 − 1 = 4.5%. Currency exposure therefore adds variability even when the underlying companies and local market are unchanged.
Why a strong dollar can hurt international stocks
For a US-dollar investor, “the dollar is strong” generally means one dollar buys more units of foreign currency. The foreign currency has weakened against the dollar, so foreign share prices translate into fewer dollars. That translation loss can outweigh a local-market gain.
| Local share-market move | Foreign currency versus USD | Approximate USD result | Interpretation |
|---|---|---|---|
| +8% | −10% | −2.8% | The dollar gain from shares is overwhelmed by currency depreciation. |
| +8% | +10% | +18.8% | Share appreciation and foreign-currency appreciation reinforce each other. |
| −8% | +10% | +1.2% | A stronger foreign currency more than offsets the local equity decline. |
| −8% | −10% | −17.2% | Both components reduce the dollar value. |
These are illustrations, not market forecasts. The direction reverses for an investor whose base currency is the foreign currency in the example. Currency has no universally good or bad direction; its effect is relative to the currency in which the investor spends, saves and evaluates performance.
Why an international fund can fall when its local market rose
An unhedged international fund owns securities whose prices are generated in several currencies. The fund administrator revalues those holdings in the fund’s reporting currency, often at each valuation point. If local share prices rise but those currencies fall against the reporting currency, the translated net asset value can decline.
Three details can make the result look different from a headline index:
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- Currency mix: A broad fund may hold yen, euros, pounds, Swiss francs, emerging-market currencies and others. The portfolio’s weighted currency result will not match any single exchange rate.
- Timing: Equity prices and exchange rates move continuously and may peak or trough on different days. A month-end comparison can differ from an intraday experience.
- Fund conventions: A fund may report a local-currency index, a currency-converted index or a hedged share class. Those are different exposures even when they reference the same companies.
To diagnose a surprising result, compare the fund’s total return in your base currency with the relevant local-market return for exactly the same dates. Then check whether the share class is marked “hedged,” the stated hedge ratio and the currencies covered.
What currency hedging changes
Hedging seeks to offset some exchange-rate exposure while keeping the foreign equity investment. A manager typically sells the foreign currency forward against the investor’s base currency. If the foreign currency falls, the hedge can gain as the shares lose translation value; if the foreign currency rises, the hedge can lose and give back that benefit.
| Approach | Currency exposure retained | Potential benefit | Trade-off |
|---|---|---|---|
| Unhedged | Nearly all, subject to portfolio operations | Participates in currency gains and preserves the diversification of foreign-currency exposure | Highest sensitivity to exchange-rate moves |
| Partially hedged | A specified fraction, such as 50% | Reduces some volatility while retaining some currency participation | Results depend on the selected ratio and how consistently it is maintained |
| Fully hedged | Most of the targeted exposure | Makes returns more closely reflect local equity performance in the base currency | Hedge costs, imperfect offsets and lost currency gains can reduce returns |
A hedge is not an insurance policy with a guaranteed payout. It can be imperfect because the hedge may cover an index currency rather than every security, may be rebalanced on a schedule and may not match the portfolio’s exact cash flows. Transaction costs, liquidity and market conditions also affect the outcome. CFA Institute’s currency-management material describes spot, forward, option and foreign-exchange-swap tools used for these exposures.
How the main hedging instruments work
Forward contracts
A forward locks an exchange rate for a future date and a stated amount. A fund that expects to receive euros but reports in dollars can sell euros forward. Forwards are widely used for institutional hedging, but they must be rolled as they mature, and the replacement rate can differ from the old one.
Futures
Currency futures are standardized contracts traded on an exchange. Standardization can improve transparency and liquidity, but contract sizes and expiry dates may not align perfectly with a portfolio’s currency exposure. Margin and daily settlement create operational requirements.
Options
A currency option provides the right, but not the obligation, to exchange at a predetermined rate. It can protect against an adverse move while retaining some upside, but the option premium is an explicit cost. The premium changes with maturity, volatility and the strike selected.
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Foreign-exchange swaps
An FX swap combines a spot exchange with a forward reversal. It can manage short-term funding or rollover needs, yet it still exposes the user to pricing, counterparty and liquidity considerations.
What determines the cost of a hedge
The most visible economic driver is the short-term interest-rate differential between the two currencies. Forward rates generally incorporate that differential, so hedging can create a positive or negative carry relative to an unhedged position. The sign and size change as central banks and money-market rates change.
Other costs include bid-ask spreads, brokerage or trading charges, collateral and the cost of rolling contracts. A fund may also incur tracking difference when its hedge schedule, notional amount or currency basket differs from the equity portfolio. A lower reported volatility does not mean the hedge was free.
Because costs are time-varying, a hedge that looked inexpensive in one interest-rate regime may be expensive in another. The relevant figure is the fund’s actual hedged-share-class performance and stated expenses over the period being evaluated, not a universal percentage.
What the historical evidence says—and what it does not
MSCI’s analysis of the MSCI ACWI ex USA Investable Market Index found that, for a US-dollar investor, currency movements eroded local-equity gains from December 31, 2021 through June 28, 2024. That finding applies to that index, investor perspective and dates; it is not a forecast for every market or future period.
In another MSCI analysis covering January 2010 through June 2024, hedging international markets generally reduced risk and increased return for US-dollar investors in the markets examined. Japan was an exception on risk: hedging increased risk in the analysis. MSCI linked the unusual result to the relationship between Japanese equities and the yen-dollar exchange rate. The result should not be exported to every country or sample period.
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MSCI’s analysis published in 2025 stresses that hedge-ratio effects differ across currency pairs and objectives. A ratio that minimizes volatility may not maximize return, and a ratio that suits a short-term liability may be inappropriate for a long-term growth portfolio.
A CFA Institute digest published in 2016 summarized a study in which factor-based, long-short country equity-index portfolios produced annual excess returns of 7%–12% in US dollars without hedging. The figure describes that specific strategy and study design—not a normal diversified investor return, a forecast or a measurement of currency’s contribution to a broad portfolio. The summary reported that exchange-rate movements did not offset the country equity return differentials in that sample.
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.How to compare hedged and unhedged investments fairly
Many comparisons fail because they change several variables at once. Keep the following aligned:
- Base currency: State whether results are measured in USD, euros, yen or another currency.
- Market and index: Identify the countries, securities and currency weights represented.
- Hedge ratio: Record whether the exposure is unhedged, partially hedged or fully hedged, and whether the ratio is static or actively adjusted.
- Dates: Use identical start and end dates. Currency regimes can change quickly.
- Return definition: Compare total returns with total returns, and confirm whether figures include fund expenses.
- Objective: Decide whether you are judging volatility, absolute return, downside protection or risk-adjusted return.
- Implementation: Account for interest-rate differentials, transaction costs, liquidity, rollover and tracking difference.
Without these details, “hedged performed better” is an incomplete statement. It may describe a particular currency, period and objective rather than a durable rule.
Should you hedge foreign stocks?
There is no universally optimal hedge ratio. The decision is a portfolio-design question rather than a prediction about next month’s exchange rate.
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- Your future spending and liabilities are almost entirely in your home currency.
- A large foreign allocation already creates substantial portfolio volatility.
- You need a relatively stable short- or medium-term value and cannot tolerate exchange-rate swings.
- Your investment policy specifically targets local-equity risk rather than total foreign-currency exposure.
When retaining currency exposure may be intentional
- You have long-term spending in the foreign currencies held.
- You want the diversification that currencies can provide when home-market conditions deteriorate.
- You accept larger short-term fluctuations in exchange for keeping potential foreign-currency gains.
- Hedging costs are high relative to the risk reduction you need.
A partial hedge can be a compromise, but it is not automatically safer or cheaper. Set the ratio from the portfolio’s objective, review how it is implemented and avoid changing it solely because the dollar or another currency recently moved.
Common mistakes and practical fixes
Mistake: treating a local index as your personal return
Fix: Use the index or fund return in your own base currency. A local-market chart answers a different question.
Mistake: assuming “hedged” means risk-free
Fix: Check the hedge ratio, rebalance frequency, currencies covered, expense ratio and historical tracking difference. Equity prices can still fall sharply in a hedged fund.
Mistake: comparing different periods
Fix: Align the dates and use the same return convention. A currency reversal near one period’s end can change the conclusion.
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Fix: Review the fund’s disclosures for forward points, rollover effects, transaction expenses and the interest-rate environment during the measurement period.
Mistake: generalizing from one country
Fix: Examine each major currency exposure. The relationship between Japanese equities and the yen, for example, produced a different hedging result in MSCI’s 2010–2024 analysis than the other markets it studied.
The practical answer for investors
Currency fluctuations affect international stock returns because the foreign shares and the investor’s measuring currency are separate sources of change. A stronger home currency usually reduces the translated value of unhedged foreign holdings; a weaker home currency usually increases it. Hedging can remove some of that exchange-rate variability, but it introduces costs, imperfect matching and the possibility of giving up favorable currency moves.
Before choosing a fund or share class, write down the base currency, the foreign markets, the desired hedge ratio, the time horizon and whether your priority is return, volatility or liability matching. Then compare like with like over the same dates. That process is more reliable than assuming either “international stocks always benefit from a weak dollar” or “hedging is always safer.”
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Sources and context
- MSCI Index Research, Global Investing: The Importance of Currency Returns and Currency Hedging, April 27, 2011.
- Dinank Chitkara, Anil Rao and Afsaneh Mastouri, MSCI, Markets in Focus: Currency Risk Higher for Global Equity Investors, July 9, 2024.
- Paul Danis, CFA Institute digest summary, What Do Stock Markets Tell Us about Exchange Rates?, September 1, 2016.
- CFA Institute, Currency Management: An Introduction, 2026 professional-learning reading.
- Anshul Kamra, Dinank Chitkara and Dimitris Melas, MSCI, To Hedge or Not to Hedge? Lessons from History for US Equity Investors, October 3, 2025.
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