💱 Currency Hedging
For US-based investors, international equity returns have two components: local market returns and currency translation. When the dollar weakens, you get a tailwind. When it strengthens, you face a headwind. Currency-hedged ETFs remove this FX exposure — giving you pure local returns. But hedging has costs and trade-offs. This page explains when to hedge and when to embrace currency exposure.
How currency affects international returns
The math of unhedged returns
When you buy an unhedged international ETF (like EFA or VEU), your return in USD equals:
USD Return ≈ Local Return + Currency Return
| Scenario | Local Return | Currency Move | Your USD Return |
|---|---|---|---|
| Both positive | +10% | EUR/USD +5% | ~+15% |
| Local up, dollar up | +10% | EUR/USD -5% | ~+5% |
| Local down, dollar down | -10% | EUR/USD +5% | ~-5% |
| Both negative | -10% | EUR/USD -5% | ~-15% |
Key insight: Currency moves can double your gains or losses. In 2022, a strong dollar wiped out gains for US investors in international stocks. In 2017, a weak dollar added to returns.
The DXY as a signal
The DXY (US Dollar Index) is the single most important indicator for currency hedging decisions:
| DXY Trend | Currency Impact | Hedging Recommendation |
|---|---|---|
| Downtrend (falling) | Tailwind for unhedged | Don’t hedge — capture currency gains |
| Uptrend (rising) | Headwind for unhedged | Consider hedging — avoid currency drag |
| Range-bound | Neutral | Either approach works |
| Sharp spike (risk-off) | Headwind | Hedging helps short-term |
Currency-hedged ETFs
These ETFs use currency forwards to neutralize FX exposure, giving you local market returns only:
Developed markets hedged
| ETF | Name | Expense Ratio | Region | Unhedged Equivalent |
|---|---|---|---|---|
| DBEF | Xtrackers MSCI EAFE Hedged | 0.35% | Developed ex-US | EFA |
| HEFA | iShares Currency Hedged MSCI EAFE | 0.35% | Developed ex-US | EFA |
| HEDJ | WisdomTree Europe Hedged Equity | 0.58% | Europe only | VGK |
| DXJ | WisdomTree Japan Hedged Equity | 0.48% | Japan only | EWJ |
Emerging markets hedged
| ETF | Name | Expense Ratio | Region |
|---|---|---|---|
| DBEM | Xtrackers MSCI EM Hedged | 0.65% | Emerging markets |
| HEEM | iShares Currency Hedged MSCI EM | 0.70% | Emerging markets |
Hedged vs unhedged: the trade-offs
Costs of hedging
| Cost | Description |
|---|---|
| Higher expense ratio | Typically 0.20-0.35% more than unhedged |
| Roll costs | Currency forwards must be rolled, creating drag |
| Interest rate differential | If foreign rates < US rates, hedging costs money |
| Tracking error | Hedging isn’t perfect — small mismatches occur |
Current context: When US rates are higher than foreign rates (as in 2023-2025), hedging has a negative carry cost. You’re effectively paying to hedge.
When hedging wins
| Scenario | Why Hedging Helps |
|---|---|
| Dollar strengthening | Avoids currency drag on returns |
| High conviction on local markets | Isolates local return, removes FX noise |
| Short holding period | Reduces volatility from currency swings |
| Tactical trade | Pure bet on local market direction |
When unhedged wins
| Scenario | Why Unhedged Helps |
|---|---|
| Dollar weakening | Captures currency translation gains |
| Long holding period (10+ years) | Currency effects tend to mean-revert |
| Diversification goal | Currency adds diversification benefit |
| Lower cost | Avoid hedging expense and roll costs |
Historical performance comparison
2014-2016: Hedging won
The dollar surged ~25% against major currencies. Hedged ETFs massively outperformed:
| Period | EFA (Unhedged) | DBEF (Hedged) |
|---|---|---|
| 2014 | -4.5% | +4.8% |
| 2015 | -0.8% | +5.6% |
| 2016 | +1.0% | +0.7% |
2017: Unhedged won
The dollar weakened ~10%. Unhedged ETFs captured the tailwind:
| Period | EFA (Unhedged) | DBEF (Hedged) |
|---|---|---|
| 2017 | +25.0% | +16.8% |
2020-2021: Mixed
Dollar volatile but ultimately weakened:
| Period | Unhedged Performance |
|---|---|
| 2020 | Unhedged slightly better |
| 2021 | Mixed, dollar choppy |
2022: Hedging helped
Dollar surged to 20-year highs:
| Period | EFA (Unhedged) | DBEF (Hedged) |
|---|---|---|
| 2022 | -14.4% | -8.2% |
2023-2025: Unhedged winning
Dollar peaked and weakened:
| Period | Trend | Winner |
|---|---|---|
| 2023-2024 | Dollar peaked | Mixed |
| 2025 YTD | Dollar falling | Unhedged |
The hedging decision framework
Short-term (< 1 year)
| DXY Trend | Recommendation |
|---|---|
| Rising / Breaking out | Hedge (HEDJ, DBEF, DXJ) |
| Falling / Breaking down | Don’t hedge (EFA, VEA) |
| Range-bound | Preference / cost matters |
Long-term (5+ years)
| View | Recommendation |
|---|---|
| No strong dollar view | Don’t hedge — currency noise averages out, save on costs |
| Structural dollar bull | Consider partial hedge |
| Structural dollar bear | Don’t hedge — capture tailwind |
The blend approach
If uncertain, you can split allocation:
| Approach | Example |
|---|---|
| 50/50 blend | Half EFA, half DBEF |
| Tactical core | 70% unhedged (VEA), 30% hedged (DBEF) |
| Regional hedge | Hedge Europe (HEDJ), leave Japan unhedged (EWJ) |
Regional hedging strategies
Europe (HEDJ)
HEDJ hedges EUR and other European currencies against USD.
When to use HEDJ:
- You’re bullish on European stocks but bearish on EUR
- Dollar is strengthening vs. EUR
- You want pure European equity exposure without FX noise
HEDJ characteristics:
- Dividend-weighted: Unlike cap-weighted EFA
- Expense ratio: 0.58% (higher than VGK at 0.08%)
- Yield focus: Higher dividend exposure than market-cap approaches
Japan (DXJ)
DXJ hedges JPY against USD.
When to use DXJ:
- You’re bullish on Japanese stocks but bearish on yen
- BOJ policy is ultra-loose (yen weakness expected)
- You want to isolate Japanese equity returns
DXJ characteristics:
- Dividend-weighted: Like HEDJ
- Expense ratio: 0.48%
- Yen sensitivity: When yen weakens, DXJ tends to outperform EWJ
The yen carry trade connection
Which hedged ETF for which situation?
| Situation | Best Choice | Why |
|---|---|---|
| Broad developed, dollar rising | DBEF or HEFA | Hedged EAFE exposure |
| Europe conviction, dollar rising | HEDJ | Europe-specific hedge |
| Japan conviction, yen weak | DXJ | Japan-specific hedge |
| EM with hedge | DBEM | Rare use case, high cost |
| Long-term hold | EFA/VEA (unhedged) | Currency mean reverts, save costs |
| Uncertain about dollar | Blend approach | Split hedged/unhedged |
Quick reference
| ETF | Region | Expense | Hedge? | Use When |
|---|---|---|---|---|
DBEF | EAFE | 0.35% | Yes | Dollar rising, broad developed |
HEFA | EAFE | 0.35% | Yes | Alternative to DBEF (iShares) |
HEDJ | Europe | 0.58% | Yes | Dollar rising vs EUR |
DXJ | Japan | 0.48% | Yes | Yen weakness expected |
EFA | EAFE | 0.32% | No | Dollar falling, long-term |
VEA | Dev ex-US | 0.03% | No | Long-term, lowest cost |
Sources
Hedged ETF information
- DBEF: Xtrackers — MSCI EAFE Hedged Equity Index
- HEFA: iShares — MSCI EAFE 100% Hedged to USD Index
- HEDJ: WisdomTree — WisdomTree Europe Hedged Equity Index
- DXJ: WisdomTree — WisdomTree Japan Hedged Equity Index
- DBEM: Xtrackers — MSCI Emerging Markets Hedged Equity Index
Currency hedging mechanics
How ETFs hedge: Currency-hedged ETFs use currency forward contracts to neutralize FX exposure. Forwards are rolled monthly, creating roll costs.
Interest rate differential: When US rates exceed foreign rates, hedging has a negative carry cost. This is embedded in forward pricing.
Vanguard research: “To hedge or not to hedge?” — Analysis of currency hedging for long-term investors.
Historical performance data
Performance comparisons derived from ETF total returns (Bloomberg, Morningstar). Past performance does not guarantee future results.
Dollar index (DXY) data from TradingView and Federal Reserve.