A fully hedged portfolio historically diminished returns when the U.S. dollar weakened or international currencies appreciated – since a hedged portfolio shorts foreign currencies, investors would miss out on the added boost from stronger international currencies. On the other hand, an unhedged strategy historically underperformed when the USD appreciated or foreign currencies weakened – if international currencies depreciate, foreign currency-denominated investments would have a lower USD-denominated return.
“Because the relationship between volatility and the amount of hedging is not linear in nature, there will likely be times when a 50% currency hedge captures a large percentage of the long-term risk reduction benefits of a fully hedged or unhedged portfolio,” according to IndexIQ.
Furthermore, the 50% hedge strategy may provide better risk-adjusted returns.
The “50% hedged exposure provides approximately 80% of the volatility reduction (between the unhedged and 100% hedged ETFs), yet also provides more consistent returns over time,” Patti added.
For more information on currency-hedged strategies, visit our currency hedged ETFs category.
Max Chen contributed to this article.