Episode 09 — The Currency Question
Duration: 14:15 minutes
Why the currency behind your basket matters as much as what is inside it — and what you can do about it.
Episode Overview
Duration: 14:15 minutes
Every investment you make exists in a currency. And when your currency and the basket’s base currency are different — the exchange rate becomes part of your return. Silently. Automatically. Whether you noticed it or not. In this episode, I explain the difference between transaction currency and base currency, why the same basket can produce different results for investors in different countries, and what two tools are available to manage currency risk. Including hedged ETFs — what they are, how they work, and whether the cost is always worth it.
What You'll Learn
- What transaction currency and base currency are — and why they are not always the same
- How currency movements can turn a positive year into a negative return
- Why the same basket produces different results in different markets
- How to reduce currency risk through local currency alignment
- What a hedged ETF is, how it works, and what it costs
Key Takeaways
Currency risk is invisible
It does not announce itself — but it silently becomes part of every return you make on a foreign asset.
It cuts both ways
Currency movements can hurt your returns — but they can also boost them. Understanding which is happening is the first step.
Hedging is a choice, not a default
Hedged ETFs reduce currency noise but add cost. Whether that trade-off is worth it depends on your portfolio and your currency.
Episode Summary (click to expand)
An overview of what’s covered in this episode.
In the last episode, we opened the basket — the ETF, the pre-arranged fund that carries your ingredients home. And we introduced something almost as a warning: currency. Today that warning gets a full conversation.
The Problem
Imagine your basket grew eight percent last year. The companies inside performed well. The index moved up. By any measure — a good year. But the currency those assets are priced in fell ten percent against your currency. Your actual return? Negative two percent. The market went up. Your basket went up. And you still lost money — in your currency terms. This is currency risk. Not because it is complicated. Because it is invisible.
Base Currency vs Transaction Currency
When you buy an ETF, two currencies are in play. The transaction currency is the currency of the market where you buy. The base currency is the currency in which the fund itself is valued — usually US dollars for globally diversified funds. Even if a fund holds companies from forty countries, it has only one base currency. Everything inside is converted into it. A Swiss broker buying on the Swiss exchange transacts in francs — but the base currency of a global fund is still dollars. Every day, that exchange rate moves. And that movement is part of your return.
The Chocolate Analogy
A Swiss chocolate company sells the same product worldwide. In Switzerland the price in francs is fixed. But every time the American importer places a new order, the dollar amount they pay is different — because the exchange rate has moved since the last order. Your ETF works the same way. The base currency price is fixed by the fund. But what you pay in your currency depends on the exchange rate at that moment — not just on what is inside the basket.
It Cuts Both Ways
Currency risk is not always bad. If the dollar falls against your currency, your dollar-based basket gains extra value in your currency terms even if the underlying assets did not move. Over ten or twenty years, currency movements will work for you in some periods and against you in others. This is not a reason to avoid global diversification. It is a reason to understand what you own.
Two Solutions
The simplest solution is to choose baskets denominated in your local currency where possible. If you earn, spend, and invest in Swiss francs — currency movements against the dollar do not affect you. You never need to convert. What you see is what you can actually use. But a globally diversified portfolio holds assets from around the world. There is no single-currency global basket.
The second solution is a hedged ETF. A hedged basket holds the same ingredients as its unhedged equivalent but adds financial agreements that offset currency movements between the base currency and your local currency. The cost of hedging varies — it is linked to the interest rate differential between the two currencies. When rates are similar, costs are modest. When they diverge significantly, the cost can rise substantially. Always check the actual hedging cost before choosing.
The Dollar — A Special Mention
The US dollar is the world’s reserve currency. More assets are priced in dollars than any other currency. For non-US investors — the vast majority of the world — dollar exposure is almost unavoidable in a globally diversified portfolio. This is not a reason to retreat from global investing. It is a reason to understand what you own, know your currency exposures, and make deliberate choices about whether and how much to hedge.
Listen to the full episode to hear each concept explained with concrete examples — including the chocolate analogy and a worked example of how the same basket produces different results in different currencies.