Located in Europe, I am thinking about a long-term (~20 yrs) investment into an ETF that follows MSCI USA Index. I am stuck: should I pick an euro hedged fund or a normal one. My salary is in Euros, my mortgage is in Euros, etc.
To hedge or not to hedge, that is the question. What are pros and cons?
So the pros are pretty simple: You in effect limit your currency risk and just get exposure to the 'true' return of the index of it's native currency. They also are generally able to hedge much cheaper than you could due to access to wholesale rates etc. Put simply: you lower your short term variance by mitigating the exchange risk.
But, and here comes the key con: hedging is never free, and these ETFs will always have marginally (and sometimes much) higher costs than the un-hedged due to the additional transactions they have to make. Not only that, but historically a lot of currencies just swing against each other and the moves basically cancel each other out over time, so long horizon investors should usually care more about these additional fees than the additional variance the un-hedged version forces them to suck up, as they add up to a lot more cost in the long run than the hedging gives back.
I like the un-hedged dollar-based investment because it diversifies the euro home-currency position.
I'd invest into funds denominated in other currencies (like Nikkei225 in YEN, FTSE100 in GBP). With this approach you will diversify your investment and currency exposure at the same time. No one would hedge a 20 year currency exposure as it was mentioned previously.During such a big time horizon it is even possible that you will obtain liabilities in USD, YEN or GBP thus effectively cancelling out some of your currency risk.
