If you own internationally focussed ASX ETFs, your returns can be impacted by the value of the Australian dollar against other currencies.
This week, the Australian dollar has gained ground against many major currencies. This comes after being historically weak for much of the year.
Most notably, AUD/USD has surged to its strongest level in six weeks.
According to analysis from The Bull, this is largely attributed to the market's interpretation that the US labor market is cooling, reinforcing expectations of imminent monetary policy easing by the Fed.
Image source: Getty Images
Why does it impact ASX ETFs?
ASX ETFs that track global markets are either hedged or unhedged.
Currency-hedged means the fund is designed to reduce (or eliminate) the impact of exchange rate fluctuations.
Therefore the recent rise of the AUD won't impact these funds. For example, if you own the iShares S&P 500 AUD Hedged ETF (ASX: IHVV), you're only exposed to the S&P 500's actual performance, regardless of currency fluctuations.
However if a fund is not hedged, when the AUD strengthens, each USD is worth fewer AUD. This means returns fall, even if the indexes like the S&P 500 Index (SP: .INX) rises.
What does it mean if you're holding non-hedged ASX ETFs?
If you already own a non-hedged ETF that's invested in US stocks, a strengthening Australian dollar can negatively impact your investment returns.
That's because your ETF holds assets denominated in U.S. dollars. When those are converted back into AUD, a stronger local currency reduces the value of those USD-denominated gains.
So even if the US market performs well, part of that growth can be offset by currency movements.
In contrast, if you own a non-hedged ETF, your returns are directly influenced by both the performance of the underlying U.S. stocks and the AUD/USD exchange rate.
What does it mean if you're looking to buy?
If you think AUD will strengthen, hedged funds can protect your returns.
If you think AUD will weaken, a non-hedged fund can potentially boost your AUD returns.
In the long-term, these fluctuations will mostly balance out. Currency-hedged funds may seem like a simpler choice. However they often come with higher fees due to the increased management required. But for some investors, this is worth the peace of mind.
If you are considering buying a US focussed ASX ETF, some common non-hedged options may include:
On the flip side, hedged ASX ETFs tracking the US market include:
