Hedged vs Unhedged ETFs: A Complete Guide for Australian Investors

When you invest in an international ETF, you're taking two bets: one on the stocks, one on the AUD. We break down exactly when hedging helps, when it hurts, and what it's actually costing you in 2026.

For most Australian investors with a 10+ year horizon, unhedged international ETFs like VGS are the better default choice because the AUD has historically weakened against the USD, giving unhedged investors a free tailwind.

• 01Hedging adds 0.1–0.2% per year in extra costs: VGS charges 0.18% vs VGAD's 0.21%, and that gap compounds over decades.
• 02VGAD underperformed VGS by roughly 1.5% per year over the five years to 2026, mostly because the AUD kept sliding against the USD.
• 03Hedged ETFs only win when the AUD strengthens, which hasn't been the dominant trend since the mining boom peaked around 2013.
• 04Hedging makes sense in two specific scenarios: you're holding for under 3 years, or the AUD is sitting at historically depressed levels (think sub-$0.60 USD).

who this is for: Australian investors deciding between VGS and VGAD (or similar hedged/unhedged pairs) for their international equity allocation.

Most Australian investors think the hedging question is simple: hedge if you want certainty, don't hedge if you want growth. That framing is wrong in almost every dimension. The real question is more nuanced - and the answer has changed dramatically since 2022 as the interest rate gap between Australia and the US opened up.

This article explains the mechanics precisely, uses real historical data to show how VGS and VGAD have actually performed across different rate environments, and gives you a decision framework that accounts for your specific situation - not a generic rule of thumb.

The two-bet problem

When you buy VGS (Vanguard MSCI Index International Shares ETF), you make two simultaneous bets: one on the performance of approximately 1,500 global large-cap companies, and one on the AUD/USD exchange rate. If global stocks rise 20% in USD and the AUD also rises 10% against the USD, your VGS return in AUD is roughly +9% - not +20%. The currency bet swallowed most of your equity gain.

VGAD (Vanguard MSCI Index International Shares (Hedged) ETF) tracks the exact same index but uses forward currency contracts to neutralise the second bet. Your return approximates the underlying index return in USD terms, converted to AUD at a fixed exchange rate. You get the stocks-only bet.

How currency hedging actually works

Hedged ETFs do not lock in a fixed exchange rate forever. Instead, the fund manager enters into a series of rolling forward currency contracts - typically one-month forwards. At the end of each month, the existing contracts are settled and new ones are entered at the current forward rate.

The forward exchange rate is not a prediction of where the AUD/USD will be in a month. It is mechanically derived from today's spot rate adjusted for the interest rate differential between the two countries - this relationship is called Covered Interest Rate Parity (CIP). If Australian interest rates are 4.35% and US rates are 5.25%, the AUD forward rate will be set such that the USD earns more over the period, making the AUD forward slightly higher than spot (reflecting the interest differential).

This is the critical mechanism: the cost of hedging is determined by the interest rate differential, not by anyone's prediction of the exchange rate. When Australian rates exceed US rates (as they did pre-2018), hedging AUD exposure to USD assets had positive carry - it actually reduced your cost. When US rates exceed Australian rates (as they have since 2022), hedging creates additional cost on top of the MER difference. The academic foundation for this comes from Solnik's seminal 1974 paper on international portfolio diversification and was formalised in the context of optimal hedging by Fischer Black in his 1990 "Universal Hedging" paper in the Financial Analysts Journal.

The true cost of hedging in 2025

Most fund comparison sites show the MER difference between a hedged and unhedged pair and call that the 'cost of hedging.' This is incomplete. The true cost has two components: the explicit MER difference and the implicit carry cost embedded in the forward contract pricing.

The carry cost of 0.90% per year is not a fee line item you'll see in the PDS - it's built into the difference between the spot and forward exchange rates used when the fund rolls its contracts each month. This means that in 2025, investors in VGAD are paying roughly 0.93% per year more than VGS investors for the same equity exposure, before any consideration of actual currency movements.

VGS vs VGAD: Year-by-year returns

Looking at calendar year returns for VGS and VGAD since their inception in 2014, a clear pattern emerges: the winner in any given year is almost entirely determined by which direction the AUD moved. In years where the AUD weakened against the USD, VGS outperformed. In years where the AUD strengthened, VGAD held the advantage.

Across the 10 calendar years shown (2015–2024), VGS outperformed VGAD in 7 of them. This is not because the stocks themselves performed differently - they track the same index. It reflects the fact that the AUD has depreciated against the USD in the majority of years since VGAD launched. The AUD/USD started 2015 at approximately 0.82 and trades near 0.63 today - a decline of roughly 23% over a decade.

The AUD as a natural hedge for global equities

Australia's dollar is classified as a 'commodity currency' - it tends to appreciate when global growth is strong and commodity prices are high, and depreciate during global downturns. This creates a natural counter-cyclical relationship with international equity markets.

When global growth is booming (typically when international equities perform well), the AUD tends to rise - which reduces the AUD returns from unhedged international ETFs. When global growth is contracting (typically when international equities are falling), the AUD tends to fall - which cushions the blow for unhedged investors. This means the AUD itself acts as a partial, imperfect hedge against global equity volatility.

Research by Campbell, Serfaty-de Medeiros, and Viceira (2010) in the Review of Financial Studies documented that currency exposure in international equity portfolios can provide a hedge against domestic economic shocks for commodity-exporting nations. Australia fits this profile exactly. Their work shows that for countries with commodity-linked currencies, the optimal hedge ratio for international equities is substantially below 100% - and may even be negative in some frameworks.

Why time horizon is everything

The strongest empirical case for not hedging long-term comes from the convergence of two effects over time: first, cumulative carry costs compound against hedged investors; second, short-run currency movements are highly uncertain, but long-run purchasing power parity (PPP) theory suggests exchange rates should converge toward fundamental fair value over decades.

For short investment horizons - say 1 to 3 years - currency movements are essentially a coin flip. You cannot reliably predict whether the AUD will be stronger or weaker in 18 months. In this context, hedging may be sensible if you need a predictable AUD outcome (e.g. saving for a house deposit). The currency uncertainty over short windows is real, even if the carry cost makes hedging expensive.

For long horizons (10+ years), two effects work against hedging: (1) the carry cost compounds continuously, and (2) the long-run trend for the AUD against developed market currencies has generally been downward over multi-decade periods, meaning the currency bet has historically paid off for unhedged Australian investors.

The chart above shows the estimated percentage of rolling periods where VGAD outperformed VGS, based on historical data. Over 1-year periods, hedged wins roughly 30–35% of the time - meaningfully below a coin flip, but not negligible. Over rolling 10-year periods, the hedged advantage appears in fewer than 25% of cases. These estimates align with research by Vanguard's own research on Australian investors, which consistently finds that for long-term investors, unhedged global equities have outperformed hedged equivalents due to the combination of AUD secular depreciation and hedging costs.

The carry cost problem: 2018–2025

The period from 2018 onward has been particularly unfavourable for hedged investors from a carry cost perspective. As the US Federal Reserve began its hiking cycle in late 2015 while the RBA remained on hold or cut, the interest rate differential that determines hedging cost flipped decisively against Australian hedgers.

From mid-2022, when the Fed aggressively raised rates to combat inflation, the differential widened further. At the peak, the Fed Funds rate reached 5.25–5.50% while the RBA's cash rate sat at 4.35%. This ~0.90 percentage point gap represents approximately 0.90% per year of additional hidden cost borne by hedged ETF investors - on top of the MER difference.

To put this in concrete terms: if you had $200,000 in VGAD instead of VGS over the past two years, the carry cost differential alone would have cost you approximately $1,800 per year in foregone return, before even accounting for any currency movement. This is a meaningful drag that is invisible in the fund's unit price but real in your total return.

When hedging actually makes sense

After presenting the case against hedging for long-term investors, it's important to be precise about when hedging is the rational choice - because there are legitimate scenarios.

• ✓Short investment horizon (1–3 years): If you're saving for a specific AUD-denominated goal - a house deposit, a car, a holiday - currency uncertainty over that window is real. Paying 0.93%/year for predictability may be a reasonable insurance premium.
• ✓High AUD conviction: If you have a well-reasoned view that the AUD is materially undervalued and likely to appreciate significantly, hedging protects your international holdings from that appreciation. Note: this is market timing and comes with all associated risks.
• ✓Approaching retirement (within 5 years of drawdown): As your investment horizon shortens, the time-based argument for unhedged weakens. Sequence-of-returns risk increases, and large currency-driven swings in your portfolio become harder to recover from.
• ✓Income-focused investors: If you depend on the predictability of distributions (e.g. in retirement), hedged ETFs provide more stable AUD distribution amounts since there's no currency component in the distribution calculation.
• ✓Conservative asset allocation contexts: Within a broader portfolio that already carries significant unhedged currency risk from other holdings, adding some hedged exposure improves overall portfolio diversification.

ETF-by-ETF comparison: hedged vs unhedged pairs

The ASX offers several hedged/unhedged pairs tracking identical underlying indexes. Here's the full cost picture for each:

VGAD vs VGS: This is the most popular hedged/unhedged pair. Both track the MSCI World ex-Australia index with approximately 1,500 holdings. VGAD's additional 0.03% MER is almost negligible - the real cost differential is the carry. Vanguard is transparent about hedging methodology in their PDS, rolling contracts monthly.

IHVV vs IVV: iShares' S&P 500 hedged pair. IHVV charges 0.10% vs IVV's 0.07% - a 0.03% MER gap identical to the Vanguard pair. The same 0.90% carry cost applies. For Australian investors wanting S&P 500 exposure, IHVV is difficult to justify unless you have a specific short-term horizon or strong AUD conviction.

HNDQ vs NDQ: BetaShares' Nasdaq 100 pair has the widest fee gap of any common hedged/unhedged pair - 0.48% vs 0.22%. This reflects the higher cost of hedging a more concentrated USD exposure. The combined true cost is approximately 1.16% per year. Given that the Nasdaq is USD-denominated tech stocks with high volatility, a weakening AUD during a tech sector correction provides meaningful return support to NDQ holders that HNDQ holders forego.

It's worth noting that all three hedging programs use monthly-rolled forward contracts, not costless perfect hedges. A practical implication is that the hedge ratio is typically set to 100% of the fund's notional exposure but the actual hedge effectiveness varies slightly due to rebalancing timing. The ASX ETF Report and each fund's annual reports include details on hedging effectiveness for investors wanting the precise numbers.

Decision framework for Australian investors

After reviewing the mechanics, costs, and historical data, here's a practical framework for making the hedging decision:

• ✓Start with your investment horizon. Under 3 years → hedging is worth considering. Over 7 years → unhedged has a strong historical advantage. 3–7 years → depends on your other factors below.
• ✓Account for your overall AUD exposure. If you own property, have super, earn in AUD, and hold Australian equities, your portfolio is already massively AUD-concentrated. Unhedged international ETFs provide genuine diversification. Hedging on top of this concentration adds little benefit.
• ✓Calculate the true cost for today's rates. In 2025, the true carry cost is ~0.90%/year on top of MER differences. Over 10 years, a 0.93% annual drag compounds to approximately 9.7% of portfolio value foregone. That's the concrete hurdle AUD appreciation would need to clear for VGAD to justify its cost.
• ✓Consider sequence-of-returns risk. If you're within 5 years of drawdown, large currency-driven portfolio swings are harder to recover from. Some hedged exposure provides stability at the cost of long-run return.
• ✓Avoid mixing without a rationale. Holding both VGS and VGAD without a deliberate reason is just paying hedging costs on a fraction of your portfolio. If you use both, know exactly why each allocation is sized the way it is.

One final consideration: the hedging question may resolve itself through super fund design. Many default MySuper options hold unhedged international equities because fund trustees, balancing long-term return maximisation against short-term volatility, have concluded that unhedged is the superior long-term positioning for most members. The same logic applies to self-directed investors building their own portfolios.