Why Holding Assets Outside the US Dollar Paid Off in 2025

The dollar was in a slump for most of 2025, for a variety of reasons. Although there’s still significant uncertainty about how changes in tariff policy will affect the economy, many investors have been expecting slower economic growth in the next couple of years. The prospect of weaker economic growth has led to less confidence in dollar-denominated assets. Concerns about the ballooning federal deficit and the stability of the US financial system have also reduced demand for dollar-based assets. In particular, many central banks around the world have been trying to diversify their reserve assets to focus more on nondollar assets, such as gold and other currencies.

As a result, the US dollar shed about 8.2% of its value against other major currencies in 2025. That raises costs for Americans traveling abroad as each dollar is worth less when converted into a foreign currency. For investors holding non-US stocks, though, dollar weakness works the opposite way, as gains on local-currency-denominated stocks are worth more when translated back into dollars. Indeed, the downtrend in the dollar is one of the main reasons international stocks outperformed in 2025. For the full year, the Morningstar Global Markets ex-US Index gained more than 32%, compared with a return of about 17% for US stocks.

But is currency exposure usually a good thing? I’ll take a look at how the dollar has fared in some previous periods and dig into the pros and cons of holding international stocks without hedging the currency exposure.

Is the Past Prologue?

Up until early 2025, the US dollar seemed virtually unstoppable. As shown in the chart below, the greenback mainly trended up and to the right from mid-2011 through late 2022. That was partly driven by asset flows into US stocks and bonds, fueled by higher economic growth in the United States compared with other global markets. In addition, the US dollar has often served as a safe-haven asset during periods of geopolitical uncertainty, such as the Russian incursion into Ukraine that started in 2022.

Currency movements can significantly affect the returns for investments based outside the United States, such as foreign stocks. During the dollar’s extended runup, US-based investors would have fared better by hedging their currency exposure. Over the trailing 10-year period ended in 2024, for example, iShares Currency Hedged MSCI EAFE ETF HEFA generated annualized returns of about 8.9%, compared with 5.1% for the exchange-traded fund’s unhedged version, iShares MSCI EAFE ETF EFA.

However, currency trends can cut both ways. The dollar went through extended periods of weakness during the 1970s, late 1980s, and between 2002 and 2008, for example. If you held international funds during those periods, you would have been much better off in an unhedged vehicle.

Long story short, the dollar waxes and wanes over time, often going through multiyear periods of strength or weakness. But over the very long term, currency movements tend to even out.

If hedging doesn’t boost returns, does it help put a damper on risk? Over time, the unhedged iShares MSCI EAFE ETF has been significantly more volatile than its hedged version. Currency hedging has smoothed the ride a bit because it neutralizes the impact of currency gains and losses, producing better risk-adjusted returns over some (but not all) periods.

From a portfolio perspective, though, keeping currency exposure unhedged can enhance diversification. Over the past three years, iShares MSCI EAFE ETF has had a correlation of 0.70 when measured against US stocks, compared with 0.75 for the hedged version. That’s not a huge difference, but indicates currency exposure is a net positive when it comes to portfolio diversification.

On the flip side, hedging currency exposure has a couple of other negatives, as well. First, there’s a cost to currency hedging. As my colleague Daniel Sotiroff pointed out, hedged ETFs often have expense ratios between 0.30% and 0.40% per year, compared with as low as 0.10% for unhedged ETFs. In addition, the forward contracts used for hedging purposes often have indirect costs that can cut into returns. Second, currency-hedged strategies tend to be less tax-efficient than unhedged ones, given the need to roll monthly forward contracts or other hedging instruments, which can lead to taxable capital gains. IShares Currency Hedged MSCI EAFE ETF has made several capital gains distributions since inception, while its unhedged counterpart has made none. As a result, the hedged version has an annualized five-year tax-cost ratio of 2.02% compared with 0.98% for the unhedged edition.

Conclusion

The question of whether to hedge or not to hedge currency exposure isn’t a straightforward one. Investors who are less risk-tolerant might consider hedging as a way to temper volatility. But for investors who seek international-equity exposure mainly for its diversification benefits, I’d lean in favor of keeping currency exposure unhedged.