Currency risk in future purchase of a currency-hedged ETF

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longvista
Posts: 193
Joined: Fri Aug 10, 2018 12:18 pm

Currency risk in future purchase of a currency-hedged ETF

Post by longvista »

Hello all!

I plan to buy a currency-hedged ETF in the future. At the moment, I am still doing some research, but in the meanwhile, my concern is that during the time that I am doing my research, I might be exposed to currency risks which would be better to minimize immediately, instead of waiting until I have finished my research.

I understand the currency risks in the case of an ETF which is not currency-hedged. This topic is well explained in the Wiki, but no explanation is given for currency-hedged ETFs.

Let's take the following 2 sample ETFs:
- ABC ETF
- ABC ETF (USD-hedged)

The underlying assets in both ETFs are:
- 50% USD
- 25% EUR
- 25% JPY

- Assume that the currency ratios of the underlying assets of the ETF remain constant throughout this exercise.
- My cash balance is EUR 100,000 and plan to invest all of it.

Suppose that after 2 months, I decide to buy the non-currency-hedged ABC ETF. In this case, between today and 2 months from now, clearly I am exposed to the currency risk which is based on the movement of the EUR/JPY exchange rate.

Therefore, to minimize my currency risk between now and 2 months from now, it would make sense to convert my balance of EUR 100,000 to:
- 50% USD
- 25% EUR
- 25% JPY

The situation with the USD-hedged version of ABC ETF is less clear. The Wiki only states: "All of the above makes the assumption that the ETF is not currency-hedged. If it is, this will significantly affect outcomes, either positively or negatively.".

I see 2 options:
a) Convert the balance of EUR 100,000 to 50% USD; 25% EUR; 25% JPY today. (same as for the non-currency-hedged ETF)
b) Convert the balance of EUR 100,000 to 100% USD.

I assume that for the currency-hedged ETF, I would minimize my currency risk by going with option b), but I am not 100% sure.

Question) Which option removes the currency risk for the situation where I plan to buy the USD-hedged ABC ETF 2 months from now?

Question) Assuming that the answer is option b), why is this the correct answer and how does currency hedging play into this?
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