Is Currency Hedging Worth It? S&P 500 Returns and the Shekel-Dollar Dilemma
Recent currency shifts have highlighted the debate over hedging foreign investments in Israel. While a weakening dollar dampened shekel returns on the S&P 500, historical data shows that hedging costs often outweigh currency losses.
The debate over whether to hedge currency exposure when investing in foreign stock indexes, particularly the S&P 500, has intensified amid recent fluctuations. In 2025, the S&P 500 climbed roughly 18%, yet Israeli investors saw only about a 3% return in shekel terms as the dollar weakened by approximately 12.5% against the shekel. From early 2025 through October 2026, the gap widened further: the index gained about 32% in dollar terms, but only around 14% in shekels.
The Mechanics and Cost of Hedging
When investing in an unhedged foreign fund, returns are driven by two factors: stock performance and exchange rates. A strengthening dollar boosts returns, while a weakening dollar erodes them. Buying a shekel-denominated fund on the Tel Aviv Stock Exchange does not automatically neutralize this currency exposure. Hedged funds use financial instruments to eliminate currency fluctuations, but this protection is not free. According to data provided by Matan Shitrit from Phoenix Holdings, the estimated annual cost of hedging averaged about 1.5% over the past decade, fluctuating based on interest rate differentials and market conditions.
A long-term analysis of Tel Aviv exchange funds reveals that unhedged funds often outperform hedged alternatives despite currency appreciation. Over a nearly nine-year period from 2018 to October 2026, the dollar depreciated by over 10% against the shekel. Nonetheless, unhedged funds outperformed hedged versions by about 1% annually in both observed firms. For instance, an unhedged S&P 500 tracking fund by Ksam delivered an average annual return of 13.1%, compared to 12% for its hedged counterpart. This indicates that the effective hedging cost during this period exceeded 2%. Extending the timeline to October 2016 largely zeroes out the performance gap before management fees, as hedging costs offset the shekel's 20% appreciation.
Volatility and Investor Behavior
While currency hedging aims to reduce risk, unhedged exposure often buffers against sharp equity downturns. In 2022, for instance, Ksam's hedged fund dropped 21.5%, surpassing the decline of the index itself, whereas unhedged investors experienced a 7.35% drop as the dollar strengthened by roughly 13% against the shekel. Institutional hedging activities—where managers buy dollars during foreign market drops to adjust exposure—frequently support the dollar during equity slumps. Consequently, the unhedged fund exhibited lower volatility, with a standard deviation of about 12% compared to nearly 16% for the hedged fund.
Ultimately, long-term calculations must contend with human behavior. Sharp short-term currency drops can trigger investor panic and impulsive portfolio shifts, even when underlying assets perform soundly. As recent market dynamics demonstrate, maintaining a portfolio aligned with personal risk tolerance remains crucial to navigating currency and market volatility successfully.
