I've noticed many popular funds investing in overseas shares offer something called a “hedged” share class.
What is it, and is it worth having? TS, via email
Investing in a fund that buys stocks in overseas markets involves taking on currency risk. A "hedged" share class aims to remove that risk.
Where funds generate returns from their overseas holdings, these are usually converted back into pounds. If the exchange rate shifts, so does the return.
For instance, take a US company whose share price grows from $10 to $11 - a $1 gain per share.
But if the dollar fell ten per cent against sterling during the period you owned the share, your gain would disappear.
Some funds will offer hedged share classes as an option for investors who want to eliminate, or partially eliminate, such effects.
These use currency exchange contracts to cancel out the impact of exchange rate movements on an investment.
If all of the foreign currency exposure of a fund is hedged against, the return should only come from the actual movement of the stocks held - as if you owned them in their local currency.
This can be beneficial or not, depending on what happens to exchange rates.
For example, the non-hedged share class of Sarasin’s Thematic Global Equity fund returned 29pc over the past year, but the hedged share class returned only 10pc.
This is because the fund is nearly 60pc invested in the US, and the pound significantly weakened against the dollar.
The ordinary share class benefited from returns being converted back into the weaker pound, which boosted sterling-denominated returns. But the hedged share class removed the currency effect.
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It can also work the other way round. The non-hedged share class of the UBS Life Japan Equity tracker fund returned 33pc between January 2012 and January 2015, whereas the hedged share class returned 93pc.
Over that period, the pound strengthened significantly against the Japanese yen. Returns from the regular share class were hurt by being converted back into a stronger pound.
For those interested in using a hedged share class, there are a few other things to bear in mind.
1. Different types of hedged share class
Some hedged share classes seek to offset 100pc of the foreign currency exposure, while some may only hedge part of the exposure.
There may also be the option to hedge back into different currencies. The vast majority of UK based investors will simply want the sterling option.
2. Costs will be higher
There are more transaction costs involved in running a hedged share class, which will affect overall return. The manager is likely to charge a higher fee.
3. Active currency choices won’t be hedged against
If the fund holds any foreign currency as an actively chosen position, this will not be hedged against.
4. Not every fund investing overseas offers a hedged share class
Hedged share classes are most common among bond funds, and although there are a number of equity funds that offer them, don't expect it to always be an option.