Could someone explain that argument to me? I don't understand currency hedging and Google's explanations are too advanced for my dainty little brain.
This seems like a test. Someone correct me where I'm wrong.
If you are Canadian and hold a fund priced in USD, your returns will be impacted both by the underlying return of the asset, and fluctuations in the CAD/USD exchange rate:
Fund doubles in price, but USD drops 50%, you make no money (in CAD), even though you should have doubled your money based on the asset return.
Fund stays same price, but CAD drops in value relative to USD. You make money even though there is no change in the underlying asset.
A hedged fund
attempts to remove the effect of currency fluctuations. They do "stuff" behind the scenes so that the impact of currency fluctuation are reduced. That "stuff" isn't free, so there are usually higher expenses than the unhedged version of the fund. Hedging also isn't perfect. It doesn't fully remove the impact of currency fluctuation.
The arguments go like this:
Pro currency hedging: You invest in CAD and you are going to spend in CAD. You don't want your returns to be impacted by the CAD/USD exchange rate. Use currency hedging to reduce the currency risk.
Anti currency hedging: Currency fluctuations are neutral in the long run, they can help or hurt you (see examples above). If you currency hedge, you are paying expenses that eat into your overall return. The tracking error isn't worth the purported safety. Also, if you check performance, currency hedging doesn't work that well?
More arguments either way probably. If you could predict in advance what the CAD/USD exchange rate would do, you'd have your answer, but if you could predict that in advance, you could just make a killing on the Forex market using your crystal ball and not need to do anything else..
Did I miss anything? How did I do?