Currency Risk in International Equity ETFs: To Hedge or Not to Hedge?

What is Currency Risk in ETF Investing?

Imagine an ETF that trades in U.S. dollars but holds stocks from the European Union, where those companies trade in euros. When you buy the ETF, you are using U.S. dollars. Behind the scenes, the ETF issuer uses those dollars to gain exposure to European equities, which means euros are involved in the process even though you never personally exchange currencies.

This creates a situation where two currencies matter at the same time. The performance of the underlying stocks is one factor, but the exchange rate between the U.S. dollar and the euro is another. The ETF’s return reflects the combination of both.

1. All else being equal, if the U.S. dollar strengthens relative to the euro, the ETF will tend to underperform. That happens because the euro-denominated stock gains are worth fewer U.S. dollars once they are translated back into the ETF’s trading currency. Even if European stocks rise in local terms, a stronger dollar can offset part or all of that gain when measured in U.S. dollars.
2. Conversely, if the U.S. dollar weakens against the euro, the ETF can outperform. In that case, the same euro-denominated stock prices translate into more U.S. dollars. Even modest local market returns can look stronger once currency effects are added on top. This is why investors sometimes see positive ETF returns even when foreign markets appear flat in headlines.

Over long periods, currency effects often tend to balance out. Exchange rates are difficult to forecast, and sustained trends are hard to predict with consistency. Despite frequent narratives about de-dollarization, or alternative reserve currencies, the U.S. dollar has remained strong relative to many major currencies in recent years and continues to function as the world’s primary reserve currency.

Currency Hedging in ETFs: EFA and DBEF

To illustrate how currency hedging can affect long-term performance results, it helps to look at two ETFs that hold the same underlying stocks but treat currency exposure differently.

The first is the iShares MSCI EAFE ETF

. With a 0.32% expense ratio, EFA tracks roughly 900 stocks across Europe, Australia, Asia, and the Far East. It has been a core international equity option in the iShares lineup since August 2001. It is also one of the most widely used international equity ETFs, with more than $70 billion in assets under management.

The comparison point is the Xtrackers MSCI EAFE Hedged Equity ETF

. DBEF owns the same underlying basket of EAFE stocks, but its benchmark is structured to hedge U.S. dollar currency exposure. That hedge slightly increases costs, with an expense ratio of 0.35%, but the fund is still large and liquid, with approximately $8.55 billion in assets.

Looking at a 14.5-year backtest from June 9, 2011, to December 15, 2025, the performance difference is striking. Over that period, DBEF delivered a cumulative return of 286.12%, translating to an annualized return of 9.75%. EFA, by contrast, posted a cumulative return of 147.74% and an annualized return of 6.45%.

The gap reflects the broader currency environment during that time. The U.S. dollar experienced extended periods of strength, particularly against the euro.

Because EFA leaves foreign exchange exposure intact, euro and yen weakness reduced U.S. dollar–based returns even when local equity markets performed reasonably well. DBEF, by hedging that currency exposure using derivatives, neutralized that effect. As a result, its returns more closely reflected the performance of the underlying companies.

In short, if an investor has a strong conviction that the U.S. dollar will weaken over time, remaining unhedged may be preferable. On the other hand, investors who want their international equity allocation to reflect stock performance alone, without currency fluctuations helping or hurting returns, may prefer a hedged option like DBEF.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.