How to protect your shares portfolio from currency risk

What is currency risk?

If you're a UK investor holding US stocks, currency movements can dramatically boost or slash your returns, sometimes by more than the stock market itself.

In 2016, the S&P 500 rose 9.5% in dollar terms, but UK investors earned close to 31% thanks to sterling's post-Brexit tumble. The following year, the tables turned, as US stocks climbed 19%, yet UK investors saw just 9% of these returns as the pound recovered.

Currency risk, also called exchange rate risk, represents this possibility of fluctuations in exchange rates affecting the value of your international investments when converted back to pounds.

As an example, when a UK investor buy shares in Apple, their broker converts their pounds to US dollars at the prevailing exchange rate. They then own a dollar-denominated asset, and when sold, those dollars get converted back to pounds at the prevailing forex conversion rate.

If the pound has strengthened against the dollar in the interim, your returns diminish. If sterling has weakened, your returns increase.

Why currency risk matters

Currency fluctuations add a layer of uncertainty to international investments that doesn't exist with domestic holdings. When you buy BP shares, you only need to worry about BP's performance. When you buy Apple shares, you're effectively making two bets: one on Apple's business performance and another on the pound-dollar (cable) exchange rate.

This dual exposure increases portfolio volatility, which is the degree to which your investment values swing up and down.

During the 2016 Brexit referendum, some UK investors saw their US holdings jump 20-30% purely from currency movements, while the underlying companies barely moved. That kind of volatility can be unsettling, particularly for investors nearing retirement or those with shorter time horizons.

It's crucial to understand that currencies don't generate returns on their own; they don't pay dividends or interest in the way shares or bonds do.

Currency movements are essentially zero sum. For every investor who benefits from a strengthening dollar, another sees their returns reduced by a weakening home currency. Over very long periods, these movements tend to cancel out, but in the short to medium term, they can significantly impact your portfolio.

Short-term vs long-term effects

The impact of currency risk depends heavily on your investment timeframe.

Short-term (1-12 months)

Currency volatility can dwarf stock market returns. Between February 1985 and 1986, sterling strengthened from $1.05 to $1.49—a massive 41.8% appreciation. During this period, the S&P 500 delivered 30.1% total returns in dollar terms, but UK investors actually lost 8% because the strengthening pound eroded all those gains and more.

Over one-year periods since 1975, the pound-dollar exchange rate has moved by an average of around 8-10% annually, with the largest swings exceeding 40% in either direction. If you're investing internationally for less than a year, exchange rates should form an important part of your decision-making, though predicting currency movements is notoriously difficult.

Long-term (10+ years)

Historical data shows that currency fluctuations have a far more muted impact over extended periods. Over rolling 10-year periods, the average annual change in the GBP/USD exchange rate typically falls to just 2-3%, and over 20-year periods it approaches 1-2%. These fluctuations tend to cancel out over multiple economic cycles as currencies revert toward their long-term averages.

For buy-and-hold investors with 10, 20 or 30-year horizons, currency risk becomes background noise rather than a primary concern. The performance of the underlying companies matters far more than exchange rate movements.

Historical S&P 500 index in USD & GBP terms

Real world examples

Let's examine how currency movements have affected UK investors in US equities over the past decade.

The Brexit effect (2016-2017)

• 2016: S&P 500 returned 9.5% in USD; UK investors earned circa 31% in GBP terms (sterling weakened dramatically)
• 2017: S&P 500 returned 19.4% in USD; UK investors earned circa 9% in GBP terms (sterling partially recovered)

Past decade

Over the decade from 2014-2024, the S&P 500 delivered substantial returns in dollar terms. However, UK investors' actual returns varied significantly based on sterling's strength:

• ·Years when USD strengthened: UK investors outperformed US investors in the same stocks
• ·Years when GBP strengthened: UK investors underperformed despite identical stock holdings

Practical example

Imagine you invested £10,000 in a US equity fund at the start of 2016 when £1 = $1.47. Your broker converted this to $14,700. By year-end, your investment grew to $16,097 (9.5% gain).

However, the pound had fallen to £1 = $1.23, so when converted back, you had £13,088—a 31% gain in sterling terms. The currency movement added over 20 percentage points to your return.

The opposite can happen too. In 2017, that £13,088 became $16,098 at the prevailing rate. The market rose 19.4% to give you $19,220. But sterling had recovered to £1 = $1.35, meaning your investment was worth only £14,237, just 9% growth.

Currency movements stripped away 10 percentage points of your return.

Pros and cons of currency hedging

Whether to hedge currency risk depends on your circumstances, time horizon and risk tolerance.

Pros of currency hedging

• Removes uncertainty — you know that changes in exchange rates won't affect your returns, making portfolio performance more predictable
• Reduces volatility — your portfolio will experience smaller swings in value, which can be psychologically easier to manage
• Useful for shorter timeframes — if you're investing for one to three years, hedging protects against significant adverse currency moves

Cons of currency hedging

• Direct costs — spread betting and CFD hedging involves spread costs and daily financing charges; currency-hedged ETFs charge additional fees (typically 0.03-0.10% annually above unhedged versions)
• Opportunity cost — if the foreign currency strengthens against sterling, you miss out on those gains
• Complexity — Hedging with derivatives requires ongoing monitoring and periodic adjustments

Risks of currency hedging

1. Wrong direction — if you hedge and the foreign currency weakens (as you feared), hedging helps. But if it strengthens, you've locked yourself out of gains while paying fees
2. Over-hedging — currency fluctuations often benefit diversified portfolios by offsetting returns in different regions
3. Implementation risk — using derivatives like CFDs adds counterparty risk and requires understanding of leverage

If you're investing internationally for 10+ years in a diversified portfolio, currency risk has historically washed out over time, and hedging costs may exceed benefits.

For shorter timeframes, concentrated positions in a single foreign market or if you have a low tolerance for volatility, hedging may be worthwhile.

However, remember that predicting currency movements is extremely difficult. Even professional forex traders struggle to beat random chance consistently.

How to hedge 

If you've decided hedging makes sense for your situation, you have three main options.

Option 1: Currency-hedged ETFs (simplest)

The easiest approach is to buy ETFs with built in currency hedging . For example:

• Unhedged — iShares S&P 500 UCITS ETF (CSP1) - 0.07% annual fee
• GBP-hedged — iShares S&P 500 GBP Hedged UCITS ETF (GSPX) - 0.10% annual fee

The hedged version automatically manages the currency exposure for you. You simply buy and hold, and the fund provider handles the hedging mechanics. The additional 0.03% fee covers their hedging costs. These can be held in ISAs and SIPPs.

Option 2: Currency ETCs (moderate complexity)

Exchange-traded currencies (ETCs) provide direct exposure to currency pairs. If you hold £50,000 in US stocks and want to hedge the dollar exposure, you could buy a GBP/USD ETC that profits when sterling strengthens (offsetting your losses on US holdings).

WisdomTree offers several currency ETCs listed on the London Stock Exchange. However, you'll need to calculate the correct position size and rebalance periodically as your equity values change.

Option 3: Spread bets or CFDs (most complex)

Using derivatives gives you precise control but requires more expertise.

Here's how it works:

If you invest £10,000 in Apple shares at a GBP/USD rate of 1.30, you receive $13,000 worth of stock. You're now exposed to dollar weakness. To hedge:

1. You need a position that profits when GBP strengthens (or USD weakens)
2. Open a long position in GBP/USD for the equivalent value
3. One CFD contract typically represents £10,000, so you'd buy 1 contract
4. If you held £50,000 in US stocks, you'd buy 5 contracts

Important considerations

• Spread bets and CFDs involve daily financing costs (typically 2-4% annually)
• You'll need to rebalance your hedge as your equity values change
• These are leveraged products requiring margin and carry additional risks
• They're not available in ISAs or SIPPs

For most retail investors, currency-hedged ETFs offer the best balance of simplicity, cost, and effectiveness. Derivatives-based hedging is typically only worthwhile for sophisticated investors with large portfolios or specific short-term needs.