Currency-Hedged vs Unhedged ETFs: A UK Investor's Guide

Two UK investors buy the same S&P 500 last year. One ends the year up 14.4%. The other is up 9.7% — same index, same period. The only difference is that one of them owned a currency-hedged ETF and the other did not, and the dollar fell against the pound.

That gap is the whole story of currency hedging, and most UK guides give it a single sentence. This one gives it the space it deserves: what a hedged ETF actually does, what it costs, and — the part that matters — when it is worth it and when it quietly drags on your returns. If you want the structured version, a structured ETF investing course walks through share-class choices like this one properly.

What is a currency-hedged ETF?

A currency-hedged ETF is a fund that owns foreign assets — say US shares priced in dollars — but uses forward contracts to cancel out the exchange-rate move, so a UK investor earns the index's return in pounds rather than a blend of the index and the dollar. The unhedged version leaves that currency exposure in place.

Put simply: with an unhedged S&P 500 ETF you are betting on American companies and the dollar. With a GBP-hedged version, you are betting on the companies alone. That is the entire difference, and whether it helps depends on which way sterling moves.

How a GBP-hedged ETF works

The hedge is not magic and it is not free, but the process is simple to follow once you see the steps.

Notice step two: the hedge is reset periodically and sized to the portfolio, which is why it is close to but never perfect. A hedged fund removes most of the currency move, not every last basis point.

Hedged vs unhedged: the number that shows the difference

Here is the clearest evidence of what hedging does. Over a recent 12-month window in which the dollar weakened against sterling, the same US index produced three very different results depending on your share class.

Read the top and bottom bars together. In dollars the index rose 14.31%. But a UK investor in the unhedged fund had to convert a weaker dollar back to pounds and ended with just 9.66% — the falling dollar ate almost five percentage points. The GBP-hedged investor kept 14.43%, essentially the full return.

What should you do with this? Recognise that in a year sterling strengthens, hedging is the difference between a good result and a mediocre one. On £10,000 that is £11,443 hedged versus £10,966 unhedged — a £477 gap created by nothing but the exchange rate. The catch: flip the dollar's direction and the arrow points the other way.

And this was not a freak year. In 2025 the pound rose 6.5% against the dollar, while the US dollar index fell around 10% — its worst calendar year since 1979. A UK investor holding unhedged US shares handed a slice of a strong American market straight back to the exchange rate, exactly as the chart shows. Dollar-down years are common enough that the currency question deserves a real answer, not a shrug.

Does currency hedging cost money?

Yes, but usually less than people fear — and sometimes it pays you. There are two separate parts to the cost, and confusing them is where most investors go wrong.

The first part is the share class's own charge. A hedged ETF typically runs 0.10% to 0.20% a year more than the unhedged version, to cover the forward contracts and their trading spreads. On £10,000 that is roughly £15 a year at the midpoint — real, but small.

It helps to know where that cost hides. A currency forward has two legs — a near leg and a far leg — and the fund pays the market spread on both each time the hedge is rolled, usually monthly. That repeated trading cost, not the headline charge, is why two hedged funds tracking the same index can post slightly different results. Small per roll, it compounds across a year.

The second part is interest-rate carry, and it can swing either way. Hedging from a lower-yielding currency into a higher-yielding one earns positive carry; the reverse costs you. The size is driven by the gap between the two central banks' rates.

Source: UBS Global Asset Management, 2025 (drag, AUM); Forbes Advisor UK and The Investors Centre, 2026 (hedging cost).

Here is why 2026 is an unusually cheap time to hedge sterling against US assets. The Bank of England base rate sits at 3.75% and the Federal Reserve holds 3.50%–3.75% — a differential of roughly zero. With rates near parity, the carry cost of a GBP hedge is close to neutral, so you are paying little more than the 0.10%–0.20% charge. When US rates towered over UK rates, that same hedge cost far more.

Hedged vs unhedged ETF: side-by-side

Strip away the jargon and the choice comes down to a handful of trade-offs. This is the hedged vs unhedged ETF decision in one view.

Source: UBS Global Asset Management and J.P. Morgan Asset Management, 2025; Bank of England and Federal Reserve rate decisions, June 2026.

The red cells are the ones that hurt. An unhedged fund suffers exactly when the pound rises, and a hedged fund suffers exactly when the pound falls — which is why neither is universally right. Your holding period breaks the tie. Before you pick a wrapper at all, it is worth understanding the difference between index funds and ETFs, because the hedged share class only exists on some products.

Should UK investors hedge currency risk?

For most long-term equity investors, the honest answer is: probably not, but it is close. Currency movements tend to average out over long horizons, while they can dominate returns over a year or two. That single fact does most of the deciding.

Lean unhedged if you are investing for a decade or more into a globally diversified portfolio. Over that span the pound's swings tend to wash out, and you avoid paying the hedging charge every year. The dollar exposure also acts as a mild shock absorber — sterling often falls in a crisis, lifting your US holdings in pound terms.

This is where time horizon does the heavy lifting. Currency swings that feel enormous over twelve months tend to fade toward zero over ten or twenty years, so the longer you hold, the less an annual hedging fee earns its place. Over a working lifetime the unhedged investor usually keeps more, simply by not paying every year to insure a risk that time already softens.

Lean hedged if your horizon is short, you will convert to pounds soon, or you simply cannot stomach watching a strong year in US shares vanish into the exchange rate. Bond investors especially favour hedging, because currency swings can swamp the modest return a bond fund is there to deliver.

What about the year ahead? Major banks see GBP/USD in a broad 1.35 to 1.47 range for 2026, clustering around 1.36 to 1.40 — but with real disagreement, from ING near 1.33 to Morgan Stanley up at 1.47. That spread is the whole point: nobody actually knows, which is exactly why building the decision on a currency forecast is a mistake. Decide on your horizon and your nerves, not on someone's price target.

One trap to avoid: do not treat hedging as a currency bet. If you are hedging because you think the dollar will fall, you have stopped investing and started speculating on FX. Hedge to remove a risk you don't want, not to predict the next move. The same discipline applies to the currency fees when buying US stocks from the UK and to choosing which ETFs European investors can actually buy — small structural choices, compounded over years.

And remember the 2026 backdrop from earlier: with UK and US rates near parity, the usual argument against hedging — "it's expensive" — is at its weakest right now. If you were ever going to hedge, a near-zero carry environment is a reasonable moment to consider it.

Frequently asked questions

Investing involves risk of loss, including the risk that currency movements work against you. This article is educational content, not investment advice.