By Gerberal | July 1, 2026 | 9 min read
In 2025, a Japanese stock ETF returned 28.1% in local currency terms. Investors holding the unhedged RMB share class got 18.0%. Investors in the USD-hedged class got 29.4% — better than the index.
An 11-percentage-point gap between two share classes of the same fund, tracking the same stocks. The difference? Currency.
If you invest across borders — buying US ETFs from Hong Kong, China A-shares from Singapore, or Japanese stocks from anywhere — currency movements can dwarf management fees, tracking error, and even the market's own return. This article explains when to hedge, when not to, and how to check what share class you're actually buying.
How Currency Affects ETF Returns
When you buy a foreign ETF, you're making two bets:
- The stock bet: the underlying companies will perform well
- The currency bet: the foreign currency will hold its value against yours
| Scenario | Stock Return (local) | Currency Move | Your Return (in home currency) |
|---|---|---|---|
| Bull market, strong FX | +20% | Foreign currency +10% vs yours | +32% 🚀 |
| Bull market, weak FX | +20% | Foreign currency −10% vs yours | +8% 😕 |
| Flat market, weak FX | 0% | Foreign currency −15% vs yours | −13% 📉 |
| Bear market, strong FX | −15% | Foreign currency +12% vs yours | −3% (cushion) |
Currency can amplify your gains or destroy them. In 2025, the RMB weakened against the US dollar and Japanese yen — turning what should have been a great year for Chinese investors holding Japanese stocks into a mediocre one, and vice versa for US-based investors.
How Currency-Hedged ETFs Work
A hedged ETF uses currency forward contracts to neutralize the FX bet:
Unhedged ETF:
Buy Japanese stocks (in JPY) → Hold them → Sell them later
Result: Stock return + JPY/USD exchange rate change
Hedged ETF:
Buy Japanese stocks (in JPY) → Enter a forward contract to sell JPY / buy USD
→ Each month, roll the forward → Sell stocks and close forward
Result: Stock return only (FX neutralized)
The forward contract locks in an exchange rate for future delivery. If the yen falls, the forward gains offset the loss on the stock position. If the yen rises, the forward loses — but the stock position gains in dollar terms. Either way, you get the stock return, stripped of currency noise.
The Cost of Hedging
Hedging isn't free. The cost is driven by the interest rate differential between the two currencies:
| Home Currency | Foreign Currency | Interest Rate Spread (mid-2026) | Hedging Cost (approx.) |
|---|---|---|---|
| USD | JPY | ~5.0% (US 4.5% − JP 0.5%) | Positive carry — hedging CREATES income |
| USD | EUR | ~2.0% (US 4.5% − EU 2.5%) | Small positive carry |
| RMB | USD | ~3.0% (US 4.5% − CN 1.5%) | Cost — hedging COSTS money |
| HKD | USD | ~0% (HKD pegged) | Near-zero — hedging is essentially free |
Key insight: When the foreign currency has higher interest rates than your home currency, hedging costs money. When your home currency has higher rates, hedging actually pays you.
For a US-based investor, hedging JPY exposure in 2026 creates a small income stream (US rates are much higher than Japanese rates). For a China-based investor, hedging USD exposure costs money (US rates exceed Chinese rates). The direction and magnitude of the spread determine whether hedging is a cost or a benefit.
Case Study: The 2025 Japan ETF Example
Using real data from a Hong Kong-listed Japan equity ETF (E Fund), here's what happened in 2025:
| Share Class | 2025 Return | What Happened |
|---|---|---|
| Underlying Index (JPY) | +28.1% | Japanese stocks had a great year |
| USD Hedged | +29.4% | Hedging created a small positive carry + stock return |
| HKD Unhedged | +29.8% | HKD is pegged to USD; benefited from the same dynamic |
| USD Unhedged | +24.0% | JPY weakened ~4% vs USD, shaving off stock gains |
| RMB Unhedged | +18.0% | JPY weakened ~10% vs RMB, destroying a third of the stock return |
The RMB investor lost 10 percentage points of return — not because the stocks performed poorly, but because the yen depreciated against the renminbi. A hedged RMB share class (if available) would have delivered something close to the 28% index return, minus a small hedging cost.
The lesson: If you're a RMB-based investor holding overseas assets in 2026, unhedged currency exposure is a major performance variable — potentially the single largest one, larger than expense ratios, tracking error, or even the market's own return in some years.
HKD: The Special Case
The Hong Kong dollar is pegged to the US dollar at roughly 7.80 HKD per USD. This means:
- HKD-hedged and USD-hedged ETFs behave nearly identically.
- Hedging between HKD and USD is essentially free (near-zero interest rate differential).
- Hong Kong investors buying US ETFs don't need to worry about currency hedging — the peg handles it.
- But if the peg were to break (a low-probability but not impossible scenario), unhedged HKD positions would experience a sharp move. Historically, the market prices peg break risk at about 2–3% probability in any given year — small, but non-zero.
For most investors, HKD functions as a USD proxy. Don't overthink hedging between these two.
RMB Volatility: The Structurally Important Hedge
The renminbi is managed by the PBOC within a daily trading band, but it can and does move — and the direction has been predominantly weaker against the dollar in recent years:
| Year | USD/CNY (approximate) | RMB vs USD |
|---|---|---|
| 2022 | 6.35 → 6.90 | RMB −8.7% |
| 2023 | 6.90 → 7.10 | RMB −2.9% |
| 2024 | 7.10 → 7.25 | RMB −2.1% |
| 2025 | 7.25 → 7.35 | RMB −1.4% |
| 2026 YTD | 7.35 → ~7.30 | RMB ~flat |
Source: PBOC daily fix, approximate year-end values.
A Chinese investor holding an unhedged S&P 500 ETF in 2024 would have received roughly +25% from the stocks minus 2% from currency = +23% net. A hedged version would have captured the full +25% — but minus a hedging cost of roughly 2–3%, arriving at approximately the same place.
Over a single year, the net impact was a wash. Over multiple years of persistent RMB weakness, hedging compounds meaningfully:
| Scenario | 5-Year S&P 500 Return | Cumulative RMB Depreciation | Unhedged Return (in RMB) |
|---|---|---|---|
| 2022–2026 (approximate) | ~+85% | ~−12% | ~+63% (net) |
The difference: ~22 percentage points over five years — roughly 4%/year. Whether hedging would have improved or worsened this depends on the hedging cost, which averaged about 2–3%/year over this period. The net benefit hedged over unhedged was roughly +1–2%/year — about as impactful as the entire expense ratio difference between a cheap ETF and an expensive one.
When to Hedge: A Decision Framework
| Situation | Recommendation | Why |
|---|---|---|
| Investing in bonds (foreign) | ✅ Hedge | Bond returns are small (2–6%). Currency swings can overwhelm them completely. Hedging makes the asset behave as intended. |
| Investing in equities (foreign), <5-year horizon | ✅ Consider hedging | Currency volatility is highest over short periods. If you'll need the money soon, protect it. |
| Investing in equities (foreign), >10-year horizon | ❌ Usually unhedged | Over decades, currencies tend to move with purchasing power parity. The hedging cost compounds, and you may not need the protection. |
| Home currency is pegged to the foreign currency (HKD/USD) | ❌ Unhedged is fine | The peg makes hedging redundant for small moves. |
| Home currency is structurally weakening (e.g., RMB vs USD) | ✅ Hedge if available | Protects against persistent depreciation. But check the hedging cost — it may eat most of the benefit. |
| Home currency is structurally strengthening | ❌ Unhedged | Let the currency gains amplify your returns. |
| Investing in a diversified global portfolio | ❌ Mostly unhedged | Currency diversification is a feature, not a bug. One currency's weakness offsets another's strength. |
| The hedging cost is very high (>2%/yr) | ❌ Unhedged | The cost of protection exceeds the likely benefit. Hedge only when the cost is reasonable. |
How to Check What You're Buying
1. Look for "Hedged" in the ETF Name
| ETF Name | Hedged? |
|---|---|
| iShares Core S&P 500 UCITS ETF | ❌ Unhedged |
| iShares S&P 500 GBP Hedged UCITS ETF | ✅ Hedged to GBP |
| Xtrackers MSCI World EUR Hedged UCITS ETF | ✅ Hedged to EUR |
2. Check the Share Class
Hong Kong-listed ETFs often have multiple share classes. The E Fund example from earlier shows the same fund listed in USD, USD Hedged, HKD, and RMB classes. The ticker suffix or share class identifier tells you which.
3. Read the Fact Sheet
The "Investment Objective" section will state whether the fund hedges currency exposure. If it doesn't mention hedging, assume it's unhedged.
Key Takeaways
-
Currency can dominate returns over short-to-medium horizons. In 2025, the RMB unhedged vs. hedged gap was 11 percentage points — far larger than any expense ratio difference.
-
Hedging cost is driven by interest rate differentials. When your home currency has lower rates than the foreign currency, hedging costs money. When it has higher rates, hedging generates income.
-
HKD investors don't need to worry about USD hedging. The peg makes them essentially the same currency for practical purposes.
-
RMB investors face a structural hedging decision. Persistent RMB depreciation means unhedged overseas holdings have a headwind. But hedging costs of 2–3%/yr make the net benefit modest.
-
For long-term equity investors, unhedged is the default. Currency diversification is part of global diversification. Hedge only when you have a specific, near-term need.
-
Always check whether your ETF is hedged. Especially with Hong Kong-listed and European UCITS ETFs, multiple share classes of the same fund can have radically different currency exposure.
Continue reading: Now that you understand currency risk, learn how ETF liquidity actually works — and why volume doesn't mean what you think.
Sources
- E Fund Management (Hong Kong) — Japan ETF multi-currency share class performance (2025–2026)
- BEA Union Investment — "To Hedge or Not to Hedge" (February 2025)
- Hang Seng Investment — ETF 102: Dual Tranche, Dual Counter Model (2026)
- Assenagon — "When Does Currency Hedging Make Sense for Funds and ETFs?"
- PBOC — daily USD/CNY central parity rate
Disclaimer: ETF Bridge is an educational resource. This article does not constitute investment advice. Currency movements are unpredictable. Hedging costs, interest rate differentials, and performance examples are current as of mid-2026 and may change. Consult a qualified financial advisor for decisions involving currency exposure. Investing involves risk, including the potential loss of principal and currency depreciation.