Investing in global markets gives you access to a wide range of economies, industries and companies, allowing you to diversify your portfolio and spread your risks. However, it also exposes you to currency fluctuations, which can impact your returns.

Even though you invest with us in pounds, some of our funds invest in non-sterling assets, which means we need to convert your money into that currency. For example, if you invest in a fund that tracks the S&P 500 Index (which tracks the 500 largest US companies) your money will be converted into US dollars before we invest it on your behalf. When you sell, the proceeds will be converted back into pounds.

Understanding currency fluctuations

Exchange rates are constantly fluctuating in response to global economic and market conditions, as well as supply and demand. This means the value of £100 in other currencies can vary significantly over time.

These fluctuations can introduce some additional variability into your returns. For example, if the S&P 500 Index rises by 10% in a year, you might only see an 8% return on your investment in an S&P 500 fund. 

This is because the price of the fund is affected by currency movements as well as how well the underlying investments perform. Additionally, the cash must be converted to pounds before being returned to you. If the US dollar weakens against the pound, you’ll receive fewer pounds when you sell your investment, reducing your overall return. Conversely, if the dollar strengthens relative to the pound, you’ll get more pounds per dollar, increasing your return. 

What is currency hedging?

To minimise the risks associated with currency fluctuations, some of our funds offer a ‘hedged’ share class. This involves using financial contracts to lock in a pre-determined exchange rate. This helps to minimise the impact of exchange rate movements on your investment returns.

We offer hedged share classes for most of our bond¹ funds and bond exchange-traded funds (ETFs)² because we believe this type of investment benefits the most from currency hedging. Bonds are often used to provide stability and balance in a portfolio, as they have historically provided more stable (though often lower) returns than shares over the long term.

By hedging bond fund investments back into your home currency, you reduce the uncertainty caused by currency fluctuations. While these fluctuations could potentially work in your favour, they could also count against you and, in doing so, reduce the benefit of holding bonds in your portfolio to reduce the overall risk.

When to use hedging

While hedged funds can reduce the uncertainty caused by currency movements, they may sometimes underperform their unhedged counterparts. However, the reason for hedging bond funds and bond ETFs is to minimise investment risk rather than maximise returns. 

In contrast, shares are inherently riskier than bonds and are primarily there to drive your investment returns. Investing in shares usually means being comfortable with a higher level of risk, which is why it’s more common for investments in shares to be left unhedged. We do not offer hedged share classes for funds or ETFs investing in shares on our UK Personal Investor platform. 

How currency hedging works

Hedging involves using derivatives (a type of financial contract) to offset the impact of exchange rate movements. These contracts typically lock in a specific exchange rate at which the manager can buy or sell the foreign currency at a future date. This reduces the risk that exchange rates will move against you. However, it’s important to note that hedging can’t eliminate all currency risk.

At Vanguard, we believe that currency hedging can support the role of bonds in a portfolio by providing stability without taking on excessive risks.

¹ Bonds are a type of loan issued by governments or companies, which typically pay a fixed amount of interest and return the capital at the end of the term.

² An ETF invests in hundreds, sometimes thousands, of individual investments, such as shares or bonds. It trades on an exchange throughout the day like a stock and will typically track a specific market, like the FTSE 100 or S&P 500.

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

ETF shares can be bought or sold only through a broker. Investing in ETFs entails stockbroker commission and a bid- offer spread which should be considered fully before investing.

Important information

Vanguard only gives information on products and services and does not give investment advice based on individual circumstances. If you have any questions related to your investment decision or the suitability or appropriateness for you of the product[s] described, please contact your financial adviser.

This is designed for use by, and is directed only at persons resident in the UK.

The information contained herein is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information does not constitute legal, tax, or investment advice. You must not, therefore, rely on it when making any investment decisions.

Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.

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