Hedged vs. Unhedged ETFs

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When you start buying international ETFs (like the S&P 500 or Global Shares), you are stepping into a bigger world. But you are also stepping into a new layer of complexity: Currency Risk. You might notice that on the ASX, there are often two versions of the exact same fund.

VGS: Vanguard MSCI Index International Shares
VGAD: Vanguard MSCI Index International Shares (Hedged)

They own the exact same companies. They cost almost the same. So, what is the difference, and which one should you choose?

Today, we are going to strip away the jargon and explain exactly what “Hedging” is, how it protects (or hurts) your returns, and whether you need it in your portfolio.

The Currency Risk Explained

To understand hedging, you first need to understand how international investing works. When you buy US shares (like Apple or Microsoft) from Australia, two things happen at once:

The Asset Layer: You buy the stock. If Apple goes up, you make money.
The Currency Layer: You have to convert your Australian Dollars (AUD) into US Dollars (USD) to buy that stock.

Because of this, your final profit depends on two moving targets: the stock price and the exchange rate.

Imagine you buy an American ETF when 1 AUD = 0.70 USD. The US stock market has a great year and goes UP by 10%. You should be happy, right?

But, during that same year, the Aussie Dollar gets stronger and goes to 0.80 USD. Because your money is now worth “less” when converted back to the stronger Aussie dollar, that currency movement eats your profit.

Stock Gain: +10%
Currency Loss: -12%
Your Result: You actually lost money, even though the market went up.

This is Currency Risk.

What is a “Hedged” ETF?

A Hedged ETF is designed to remove that second layer.

When you buy a Hedged ETF (like VGAD), the fund manager uses financial tools (called forward contracts) to lock in the exchange rate. They effectively “cancel out” the movement of the Aussie dollar.

If the US Market goes up 10%: Your Hedged ETF goes up 10%.
If the US Market goes down 10%: Your Hedged ETF goes down 10%.

It doesn’t matter if the Aussie dollar crashes to 50 cents or soars to $1.10. You get the pure return of the companies you invested in.

The Pros of Hedging

1. Protection from a Rising Aussie Dollar

This is the main reason to hedge. If you believe the AUD is going to get stronger (rise against the USD), you want to be hedged. If the AUD goes from 65c to 80c, unhedged investors lose value. Hedged investors are protected.

2. Pure Exposure

If you are the type of person who looks at a chart of the S&P 500 and says, “I want that return exactly,” hedging gives you that. You remove the “noise” of currency fluctuations.

3. Sleeping Better (Reduced Volatility… Sometimes)

For some investors, having their portfolio swing around because of currency news is stressful. Hedging removes one variable from the equation.

The Cons of Hedging

If hedging protects you, why doesn’t everyone do it?

1. No Protection on the Downside

This is the biggest secret in Australian investing (also called as The “Buffer” Effect). Historically, the Aussie Dollar is a “risk-on” currency.

When the world economy crashes: Global stock markets fall… but the Aussie Dollar usually falls too.
The Magic Buffer: If your US shares drop 20%, but the AUD drops 20% at the same time, your unhedged portfolio value stays roughly the same! The falling dollar acts as a natural cushion.
Hedged Failure: If you are Hedged, you don’t get this cushion. You take the full 20% loss.

2. Higher Fees

Hedging takes work. The fund managers have to buy contracts and trade currencies. Because of this, Hedged ETFs usually have slightly higher management fees.

Example: VGS (Unhedged) is 0.18% vs VGAD (Hedged) is 0.21%.

3. Tax Drag

This is complex, but important. Because the fund has to constantly buy and sell currency contracts to maintain the hedge, they often generate “realized gains” that must be distributed to you as taxable income. This can increase your tax bill at the end of the year, even if you didn’t sell any ETF units.

Examples (ASX)

Here are the most common pairs you will see on the Australian market.

Region	Unhedged ETF (The Standard)	Hedged ETF (The Currency Protected)
Global Shares	VGS (Vanguard International)	VGAD (Vanguard International Hedged)
USA (S&P 500)	IVV (iShares S&P 500)	IHVV (iShares S&P 500 Hedged)
Global Quality	QUAL (VanEck Quality)	QHAL (VanEck Quality Hedged)

A 10-Year Look Back

Over the last decade, the Aussie Dollar has slowly drifted down (from ~$1.00 USD in 2012 to ~$0.65 USD in 2023). Because the dollar fell, Unhedged investors made more money. They got the stock growth PLUS the currency bonus.

Invested in VGS (Unhedged): You won.
Invested in VGAD (Hedged): You still made good money, but less than the unhedged version.

Note: Just because this happened in the past does not mean it will happen in the future.

So, Which One Do I Choose?

There is no “right” answer, but there are three common strategies in the FIRE community:

Strategy 1: 100% Unhedged

Logic: Over the very long term (20+ years), currency fluctuations tend to even out. Plus, you get the benefit of the “natural buffer” during crashes and lower fees.
Who is it for? Young investors with a long timeline.

Strategy 2: The “Tactical” Approach

Logic: You try to guess the currency. “The AUD is really low right now (65c), so it has to go up. I will buy Hedged.”
Who is it for? People who like to gamble on macroeconomics. (We generally don’t recommend this—predicting currency is incredibly hard).

Strategy 3: 50/50 Split

Logic: I have no idea what the dollar will do. So, I will put 50% of my international money in VGS and 50% in VGAD.
Result: You are now currency neutral. If the dollar goes up, your Hedged half wins. If the dollar goes down, your Unhedged half wins. You eliminate the risk entirely.
Who is it for? Retirees or those with large portfolios who want to minimize regret.

Conclusion

Hedged ETFs are a powerful tool, but they are not mandatory.

For most beginners starting with small amounts, sticking to standard Unhedged ETFs (like VGS or IVV) is perfectly fine. It keeps your fees low, your taxes simple, and gives you that nice “cushion” when markets get scary.

As your portfolio grows, you might consider adding some Hedged units to balance things out—but don’t lose sleep over the currency layer. Focus on the asset layer; that’s where the real wealth is built.