Currency risk: the second bet inside every international fund

When you buy an international fund from India, you are making two bets, not one. The first is on the foreign market. The second is on the rupee. Most investors know only about the first, and the second has frequently mattered more.

The arithmetic of the second bet

Your return in rupees is, approximately:

Return in rupees ≈ foreign market return + currency movement

Work through it. You invest ₹1,00,000 when the dollar is at ₹83, buying about $1,205 of a US fund. A year later the fund is up 10% in dollars, so you hold $1,325. If the rupee has weakened to ₹87, that is ₹1,15,300 — an rupee return of about 15.3% on a 10% dollar return.

Reverse the currency move to ₹79 and the same 10% dollar gain becomes about 4.7% in rupees.

Same fund, same market, same year. A five-point difference in the exchange rate produced a ten-point difference in your return.

Why this has historically helped Indian investors

The rupee has depreciated against the dollar over long periods — driven by the inflation differential between India and the US, and by India's structural current account position. The economic logic is straightforward: if Indian prices rise faster than American ones, the currency adjusts over time.

For an Indian holding unhedged foreign assets, that has been a tailwind, adding meaningfully to long-run returns from international funds beyond what the foreign market itself delivered.

Three cautions attached to that comfortable observation:

• The rate is not the trend. The rupee has had multi-year stretches of stability and periods of appreciation. A tailwind averaged over twenty years can be a headwind for five.
• The inflation differential has narrowed. As Indian inflation has come down towards developed-market levels, the structural case for continued depreciation at the historical pace is weaker than it was.
• A tailwind is still a bet. Being right for structural reasons does not make it not a risk.

Where it helps and where it hurts

Currency is a genuine diversifier, and this is the strongest argument for it. Global risk-off events tend to strengthen the dollar and weaken emerging market currencies including the rupee — at the same time as Indian equity falls. So an unhedged international fund gets a currency gain precisely when your domestic portfolio is falling. The two exposures offset in exactly the scenario where you want offsetting.

Currency is a liability mismatch, and this is the strongest argument against oversizing it. Your school fees, rent, EMIs and retirement are all in rupees. Holding a large share of your wealth in dollars introduces a mismatch between your assets and your obligations. This is precisely why a 10–25% international sleeve is a reasonable range and 50% is not.

Hedged versus unhedged

Unhedged — you take the currency movement. Most Indian international funds are unhedged, and for a long-horizon investor this is usually the right default: you get the diversification benefit, the historical depreciation tailwind, and no hedging cost.

Hedged — the currency exposure is removed using forwards, so you receive the foreign market's return in rupee terms.

The catch is cost, and its direction is not neutral. Hedging cost is approximately the interest rate differential between the two currencies. Indian rates are structurally higher than US rates, so hedging dollar exposure back into rupees typically costs an Indian investor, not the reverse. You pay a recurring premium to remove an exposure that has historically been a tailwind.

The practical guidance:

• Long horizon, diversification motive → unhedged. The currency exposure is doing the job you wanted.
• Short horizon with a rupee liability at the end → the currency risk is real and unwelcome, but the answer is usually not a hedged fund; it is to not use a foreign asset for a near-term rupee goal at all.

The other currency exposures you did not notice

• A rupee-denominated fund is not rupee-exposed. The international fund reports NAV in rupees while holding dollar assets. The reporting currency tells you nothing about the exposure.
• Gold is a dollar asset. Rupee gold prices carry the currency move, which is part of why gold has worked as an Indian hedge.
• Your "domestic" fund has dollar earnings. IT services and pharmaceutical companies earn in dollars, so a large-cap Indian fund carries an implicit currency exposure — see global macro.
• Overseas education or travel is a dollar liability, which is a genuine and underused argument for holding foreign assets against it. If your child may study abroad in twelve years, the currency exposure inside an international fund is not a risk to that goal — it is a hedge for it. See investing for children's education.

Pitfalls to avoid

• Ignoring the currency entirely. Half your return may come from it.
• Assuming the rupee will always depreciate at the historical pace. The inflation differential that drove it has narrowed.
• Paying to hedge for a long-horizon holding. You are paying a recurring cost to remove a historical tailwind and a genuine diversifier.
• Over-sizing foreign exposure. Your liabilities are in rupees.
• Using a foreign fund for a near-term rupee goal. Two volatile variables, one fixed date.
• Attributing a good year to fund selection when it was the currency. Check the fund's return in its own currency before concluding anything about the manager.

Key takeaway

An international fund is two bets: the foreign market and the rupee — and a five-point move in the exchange rate can swing your return by ten points on the same underlying performance. Rupee depreciation has been a long-run tailwind for Indian investors and, more usefully, the currency strengthens exactly when domestic equity is falling, which is a real diversification benefit rather than a lucky one. Stay unhedged for long-horizon diversification — hedging costs an Indian investor because domestic rates are higher — and size the sleeve at 10–25% of equity, because your school fees, EMIs and retirement are all denominated in rupees.