A rapid decline in the won-dollar exchange rate is dividing fortunes among investors in overseas equity exchange-traded funds. Even ETFs tracking the same US S&P500 or NASDAQ 100 index are posting returns that differ by more than 8 percentage points over the past three months, depending on whether they hedge against currency movements or leave investors fully exposed to exchange rate swings.
According to ETF Check on Wednesday, the KODEX US S&P500 posted a three-month return of minus 7.68 percent as of Tuesday. By contrast, the KODEX US S&P500(H) — which tracks the same S&P500 index but employs currency hedging — returned 0.89 percent over the same period. The gap between the two stands at 8.57 percentage points, with one group of investors sitting on losses while the other is in positive territory.
A similar divergence has emerged in NASDAQ 100 products. The TIGER US NASDAQ 100 posted a three-month return of minus 11.88 percent, while the TIGER US NASDAQ 100(H) recorded minus 3.68 percent — a much smaller loss. The gap between the two products is 8.20 percentage points. Looking at just the past month, the unhedged version returned minus 0.59 percent while the hedged version gained 3.33 percent, with the two funds moving in opposite directions entirely.
The underlying US stocks held by both ETFs have not changed. The key variable driving the return gap is the exchange rate. Overseas equity ETFs listed in South Korea are bought and sold in won, but the assets they hold are denominated in dollars. As a result, the returns of an unhedged ETF reflect not only the performance of US stocks but also changes in the value of the dollar.
Consider a simple example: an investor holds $100 worth of US stocks. When the exchange rate stands at 1,500 won per dollar, that position is worth 150,000 won ($109) in won terms. If the exchange rate falls to 1,370 won while the stock price stays flat, the same $100 is worth only 137,000 won. Even though the stock itself recorded no loss, the investor faces a currency loss of roughly 8.7 percent once the position is converted back into won.
In short, investing in an unhedged overseas equity ETF is in effect equivalent to investing in US stocks and the dollar simultaneously.
Recently, it is the dollar component that has inflicted the heavier losses. The won-dollar rate climbed to a closing price of 1,555.8 won on July 2 but fell back to 1,370.4 won on Tuesday — a decline of 11.9 percent in roughly two months. During intraday trading on Tuesday, the rate dropped as low as 1,364.3 won.
Because the exchange rate fell so sharply in a short period, currency losses from won strength had a greater impact on ETF returns than the movement of US equity markets.
Currency-hedged ETFs use derivatives such as dollar futures and forward exchange contracts to reduce this kind of exchange rate exposure. By locking in a future selling rate for dollars in advance, these funds offset the decline in the won-denominated value of their US stock holdings when the dollar weakens.
The "H" appended to a product name stands for "hedge." A fund with "(H)" at the end of its name — such as KODEX US S&P500(H) — generally employs a currency-hedging strategy. Products that do not hedge are referred to as "currency open" or "currency exposed." Some asset managers use the designation "UH" for "unhedged."
However, investors should not rely solely on the product name. Even when "H" does not appear in the name, the specific hedging policy can vary by product — some funds hedge only a portion of their assets or set a separate target hedging ratio.
The most reliable approach is to check the asset manager's website or the fund prospectus for disclosures on currency hedging policy, currency risk management, and hedging details.
The recent outperformance of hedged ETFs reflects the sharp appreciation of the won. The Bank of Korea's Monetary Policy Board raised the benchmark interest rate by 0.25 percentage point on Aug. 27, lifting it from 2.75 percent to 3.00 percent annually.
In the United States, concerns about the possibility of further Federal Reserve rate hikes persist, though comments tempering those expectations have also emerged. US Treasury Secretary Scott Bessent signaled caution about additional rate increases in the face of supply shocks, and President Donald Trump reiterated his view that US interest rates are too high. These remarks have acted as a brake on unilateral dollar strength.
On top of that, end-of-month dollar selling by export companies added to downward pressure on the exchange rate, accelerating the won's recent advance. As the rate fell nearly 10 percent, investors in unhedged ETFs absorbed substantial currency losses independent of how US stocks performed. Hedged ETFs, by largely blocking that impact, were able to post return gaps of around 8 percentage points against funds tracking the same index.
Investors should note, however, that the recent strong performance of hedged ETFs does not mean they are always the better choice. If the exchange rate moves in the opposite direction, so do the results. When the won weakens and the dollar rises, unhedged ETFs can add currency gains on top of US stock returns. Hedged ETFs, by contrast, largely neutralize the benefit of a rising dollar, meaning they can underperform unhedged funds even when the underlying index rises.
Currency hedging also carries costs. Funds must continuously trade forward exchange contracts or currency futures and roll over positions as they mature. The expenses incurred in this process, along with interest rate differentials and market conditions, are all reflected in ETF returns.
There are also differences in the funds' own management fees. The total expense ratio for KODEX US S&P500 is 0.0062 percent per year, compared with 0.0099 percent for KODEX US S&P500(H). For TIGER US NASDAQ 100, the ratio is 0.0068 percent annually, while TIGER US NASDAQ 100(H) charges 0.07 percent. On a simple fee comparison, the hedged versions cost roughly 10 times more.
th5@heraldcorp.com
