When investing internationally, many Australian investors turn to ETFs like Vanguard MSCI Index International Shares (Hedged) ETF (VGAD) and Vanguard MSCI Index International Shares ETF (VGS). Both ETFs offer exposure to a broad range of global companies, providing diversification outside Australia.

But there’s a key difference between them: VGAD hedges against currency movements, while VGS doesn’t. This hedging approach can impact your returns, especially when the Australian dollar (AUD) fluctuates. Understanding how this plays out is important for making the right choice for you.

This article breaks down the main differences between VGAD and VGS and how each ETF works. We’ll cover everything from costs and currency impact to risk and investor suitability, to help you decide which fund aligns with your goals.

Let’s see how VGAD and VGS stack up.

Overview of Vanguard MSCI Index International Shares ETF

VGS gives investors access to a broad portfolio of international shares, focusing on large and mid-sized companies in developed markets. This ETF provides exposure to companies outside Australia, covering regions like North America, Europe, and Asia. With VGS, investors gain access to well-established companies across various industries.

This ETF doesn’t hedge against currency fluctuations. This means returns may vary based on changes in the value of the AUD against other currencies. For some investors, this currency exposure offers an opportunity to benefit when the AUD weakens – but also poses the commensurate risks (which we'll explore later) .

VGS holds companies across major sectors, including technology, finance, and healthcare, allowing investors to spread their exposure across industries. This range seeks to offer a balanced approach for those seeking long-term growth through a diversified portfolio of international holdings.

Overview of Vanguard MSCI Index International Shares (Hedged) ETF

VGAD gives Australian investors access to a diversified portfolio of international shares. It covers companies in developed markets like the US, Japan, and Europe, focusing on established, high-cap companies. This international exposure aims to broaden investment opportunities beyond Australia.

Like VGS, VGAD’s portfolio spans various sectors, reducing risk by spreading exposure across industries. This broad sector range can help balance risk within a portfolio focused on long-term growth.

A standout feature of VGAD is its currency hedging . Hedging minimises the impact of currency fluctuations, helping to stabilise returns when the AUD changes in value. This means VGAD’s returns are less affected by shifts in currency exchange rates. VGAD’s currency hedging sets it apart from unhedged ETFs, offering stability for investors mindful of the AUD’s impact on returns.

Hedging vs non-hedging: what investors should know

As you may have guessed by now, the main difference between VGAD and VGS is currency hedging. VGAD uses hedging to offset currency movements, while VGS remains unhedged.

What is currency hedging?

Currency hedging is a strategy that aims to protect investments from fluctuations in exchange rates. When you invest internationally, currency values can impact your returns. For instance, if you hold a US stock and the US dollar weakens against the Australian dollar, your returns may drop once converted back to AUD.

With hedging, an ETF like VGAD offsets these shifts. It uses financial contracts to “lock in” an exchange rate, shielding returns from currency swings. So, if the AUD strengthens or weakens, VGAD’s hedging limits the potential impact on your investment.

Think of hedging as adding a stabiliser to your returns. It won’t eliminate all risks, but it can smooth out the effects of currency ups and downs. Hedging can be useful for investors who want more predictable, AUD-based returns without worrying about how foreign currencies perform.

How does it affect VGAD versus VGS returns?

VGAD’s hedging strategy minimises the impact of AUD fluctuations on returns. As VGS doesn’t hedge, currency movements can impact returns directly. When the AUD weakens, VGS’s returns can benefit from the increased value of foreign currencies. However, if the AUD strengthens, returns may decrease. For some, this currency exposure can offer a potential opportunity to gain from AUD shifts over time.

Risks of investing in VGS vs VGAD

Both VGS and VGAD carry risks, but their approaches to currency handling make their risk profiles different. Here’s what you should know.

As we mentioned, VGS, being unhedged, exposes investors to currency fluctuations. This can increase short-term volatility, particularly when the AUD changes significantly. Though VGS can benefit from a weakening AUD as the value of foreign holdings rises, this adds an extra layer of risk.

As detailed above, VGAD’s currency hedging can reduce the impact of currency swings. This added stability may lower short-term volatility in returns, especially when the AUD is strong. However, like all hedged funds, VGAD could underperform unhedged options when foreign currencies strengthen against the AUD.

Both funds are influenced by global market conditions, with VGAD offering an AUD-based return due to hedging. VGS may experience more variable returns because of currency exposure. In a volatile market, VGAD’s stability might appeal to more risk averse investors looking to limit currency impact. VGS, in turn, could attract investors who are okay with currency-driven shifts. This difference comes down to your comfort level with currency risk and what you want to achieve in your portfolio.

Both ETFs offer solid potential for growth through international shares. Choosing one depends on how you feel about the impact of currency on your returns.

What are the costs to consider?

Regarding costs, VGAD and VGS are once similar, but maintain some key differences.

• Management expense ratio (MER): VGS has a slightly lower MER than VGAD. If keeping costs down is a top priority, VGS might be appealing for its cost-effectiveness in getting international exposure without added hedging fees.
• Extra hedging costs with VGAD: Since VGAD uses hedging to manage currency risk, it has a slightly higher MER to cover these costs. This small fee difference might be worth it for investors who want smoother, AUD-based returns and less exposure to currency swings.
• Impact on long-term returns: Over time, even small fee differences add up. Lower costs in VGS could boost your returns over the years, especially if you’re comfortable with currency fluctuations. However, VGAD’s hedging fee might feel appeal if stability is your focus.

The choice between VGAD and VGS is about what you value more – low fees or hedged returns.

VGAD or VGS? Key factors to consider

Both VGAD and VGS offer great international exposure, but they cater to different investor preferences. Here’s a quick comparison to help you decide which might align better with your goals.

Feature	VGAD (Hedged)	VGS (Unhedged)
Currency management	Hedged against currency movements	Unhedged; exposed to currency shifts
Impact of AUD changes	Minimised through hedging	Direct impact from currency changes
Management fees (MER)	Slightly higher due to hedging	Lower without hedging costs
Return stability	AUD-focused	Higher potential volatility
Suitable for	Stability-seekers, hedging fans	Growth-seekers comfortable with currency risk

And you might want to consider these questions when choosing between VGAD and VGS:

• How comfortable am I with currency fluctuations? Am I okay with returns influenced by shifts in the AUD, or do I prefer a more stable, AUD-focused return?
• What role does stability play in my portfolio? Would I benefit from VGAD’s hedging, which aims to reduce currency-driven volatility, or am I open to the currency-based swings of VGS?
• How do I view cost efficiency in my investment strategy? Do I prioritise the lower MER of VGS for long-term cost savings? Or would I consider VGAD’s slightly higher MER worthwhile for its hedging benefits?
• What’s my main goal for this investment? Am I focused on capital growth with a tolerance for some volatility, or do I prefer potentially steady returns that align more closely with the AUD?
• Do I see currency exposure as an opportunity or a risk? Would I appreciate the potential upside of foreign currency appreciation with VGS, or do I prefer VGAD’s effort to smooth out currency effects?
• How does this ETF fit with my broader portfolio? Would VGAD’s stability complement a portfolio already exposed to other risks, or would VGS add useful diversification with its currency exposure?
• How important is inflation protection to me? Do I want the potential inflation-buffer benefits of VGS’s currency exposure, or am I comfortable with VGAD’s focus on AUD stability?

Answering these questions can help clarify which ETF better aligns with your long-term goals, risk tolerance, and portfolio strategy. You might also want to look at both ETFs side-by-side using Pearler’s Compare tool .

Can I invest in both?

Some investors might choose to include both VGAD and VGS in their portfolio when they want a balance between stability and growth potential from currency exposure. That being said, by investing in both, a portfolio may come to suffer from asset overlap . This can make it challenging when trying to rebalance your portfolio. Hence, it's important to consider whether holding two similar ETFs are beneficial to you. Here are some scenarios where holding both could make sense:

1. Diversifying currency exposure :
   Including both can allow investors to diversify their currency exposure. VGAD seeks to offer stability by hedging currency risks, while VGS provides exposure to foreign currencies, which can potentially benefit returns if the AUD weakens.
2. Smoothing out volatility while pursuing growth :
   Combining VGAD and VGS can offer a middle ground, where VGAD’s potential stability balances VGS’s potential for higher returns. This approach could theoretically reduce the impact of currency swings while still allowing for some gains when foreign currencies appreciate.
3. Adapting to varying market conditions :
   Having both ETFs could prepare investors for different economic environments. VGAD might perform well when the AUD strengthens, while VGS could see gains when the AUD weakens, offering a buffer for changing currency dynamics.
4. Hedging against inflation :
   As mentioned, VGS may provide inflation protection if foreign currencies increase in value relative to the AUD. VGAD, meanwhile, keeps returns more stable in AUD terms, allowing an investor to hedge against inflation both domestically and internationally.
5. Flexible rebalancing opportunities :
   Holding both VGAD and VGS allows investors to adjust allocations as their strategies change. For example, if AUD stability becomes a priority, they could increase VGAD exposure.

Holding both VGAD and VGS may give you the flexibility to capture currency-based gains while managing volatility. It can be a strategic choice for a balanced, adaptable international portfolio. However, it's important to note that no combination can eliminate the risk factor inherent in investing. In fact, in some cases it may not be beneficial to hold two very similar ETFs that overlap in your portfolio.

The bottom line

Choosing between VGAD and VGS depends on your goals – growth, inflation protection, or currency stability – and how you view currency risk. Both bring unique strengths and can play valuable roles in international investing . Think about how each ETF aligns with your goals and comfort with risk. Whether you choose one or both, you’re gaining international diversification – a popular goal for many investors seeking a balanced, long-term portfolio.

Happy investing!