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Fund Spy

To Hedge or Not to Hedge?

A look at currency movements and mutual funds.

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When glancing at the currency exchange rates, some of us may think back to happy times when the strong greenback allowed us to shamelessly order the most expensive pasta dish on the menu while in Rome. More recently, perhaps, we've sheepishly ordered tap water and skipped dessert at a Parisian bistro.

Putting travel dining aside, currency movements also affect your foreign holdings, for better or worse. So it's important to understand whether your funds' strategies incorporate currency hedging and what that can mean relative to the other mutual funds in your portfolio.

To illustrate, if a portfolio manager allocates 50% of a fund to Japanese stocks, then 50% of the fund's gains or losses will be yen-denominated. If the yen appreciates after the manager buys a Japanese stock, the fund's shareholders reap the extra gain. If the yen sinks, well, then shareholders take that loss on top of any movements in the stock price. However, that may not always be the case. If the portfolio manager hedges that yen exposure back to U.S. dollars through forward contracts or currency options, this takes the effect of the yen's movements out of the picture. It's rather hard to find these funds, but some managers may hedge away 100% (or almost all) currency exposure. Mutual Series and Tweedy Browne are examples of fund shops that have fully hedged funds.

Karin Anderson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.