Hedged vs Unhedged ETFs: Which Should Canadians Buy in 2026?
Almost every popular foreign-market ETF in Canada comes in two flavours: a CAD-hedged version that strips out currency swings, and an unhedged version that lets the loonie do whatever it wants. The wrong choice can quietly cost you 0.5 to 1.0 percentage point a year over decades. Here is exactly when each one wins.
What does "currency hedged" actually mean?
When a Canadian investor buys a foreign ETF, two things move their return: the price of the underlying stocks, and the exchange rate between the Canadian dollar and the foreign currency. A currency-hedged ETF uses short-term forward contracts to cancel out the exchange-rate movement, so you only get the stock return translated at a fixed rate.
For example: if the S&P 500 returns 10 percent in USD over a year and the US dollar falls 5 percent against the loonie, an unhedged Canadian investor earns roughly 5 percent. A hedged investor earns roughly 10 percent, less the cost of hedging.
The hidden cost of currency hedging
The published MER of a hedged ETF and its unhedged twin is often identical (around 0.09 percent for VSP and VFV). The real cost shows up as tracking error - the gap between the fund's return and the index it tracks. Rolling forward contracts every month is not free, and the cost varies with interest-rate differentials and FX volatility.
Vanguard's own research and academic studies put the typical hedging drag at 0.30 to 0.70 percentage points per year for CAD/USD products. It compounds. Over 30 years, that is the difference between $100,000 growing to $1.74M (unhedged at 10%) and $1.46M (hedged at 9.4%).
Hedged vs unhedged: the historical scoreboard
Over the long term, unhedged usually wins for Canadian investors holding US and global stocks. The reason is structural: when global equity markets crash, investors flee to the US dollar, which tends to strengthen. That USD strength partially cushions the equity drop for unhedged Canadians. Hedging deliberately removes that cushion.
| Period | VFV (unhedged) | VSP (hedged) | Gap |
|---|---|---|---|
| 10-year annualized | ~14.5% | ~13.8% | 0.7% |
| 5-year annualized | ~15.1% | ~14.2% | 0.9% |
| 3-year annualized | ~13.7% | ~13.0% | 0.7% |
| 2020 drawdown peak-to-trough | -21% | -32% | Unhedged cushioned the fall |
| 2022 calendar year | -13.2% | -18.1% | CAD weakness softened the drop |
The pattern is consistent across decades: in major US-market drawdowns (2008, 2020, 2022), the loonie weakens, the US dollar rallies, and unhedged Canadian investors take a smaller hit in CAD terms. The bull-market gap is smaller, but it stacks year after year.
The popular Canadian ETF pairs
Almost every foreign-equity ETF on the TSX has a hedged and unhedged twin. Here are the most common pairs Canadian DIY investors face:
| Index / region | Unhedged ticker | CAD-hedged ticker | MER |
|---|---|---|---|
| S&P 500 (Vanguard) | VFV | VSP | 0.09% |
| S&P 500 (BMO) | ZSP | ZUE | 0.09% |
| S&P 500 (iShares) | XUS | XSP | 0.10% |
| Nasdaq 100 (BMO) | ZNQ | ZQQ | 0.39% |
| Developed ex-NA (iShares) | XEF | XFH | 0.22% / 0.22% |
| Emerging markets (iShares) | XEC | XEM | 0.27% / 0.81% |
| Total US market (iShares) | XUU | XUH | 0.07% / 0.21% |
When hedged ETFs actually make sense
Hedged ETFs are not bad products. They are the right choice in specific situations, but those situations are narrower than most retail Canadians realize.
Choose hedged if
- Your time horizon is short (under 5 years)
- You need predictable CAD-denominated returns (near-retirement, planned purchase)
- You will spend the proceeds in CAD and want to lock in today's exchange rate
- You hold the fund inside a registered account where short-term volatility matters more than long-term return
Choose unhedged if
- Your horizon is 10+ years (almost all retirement investors)
- You want the natural USD cushion during equity drawdowns
- You want lower tracking error and slightly cheaper fees
- You are building a globally diversified portfolio (think XEQT, VEQT, XAW)
Account placement: does hedging change the math?
Account choice does not change the core question - hedging cost compounds the same way in a TFSA as in a non-registered account. But your account does affect a related issue: foreign withholding tax on US dividends. In an RRSP, holding the US-listed version of an ETF (like VOO) avoids the 15 percent US withholding entirely, regardless of hedging.
QUICK DECISION FRAMEWORK
- TFSA, long horizon: Unhedged (VFV, ZSP, XUS). Lower drag, better USD cushion.
- RRSP, long horizon: Unhedged - and if you can convert via Norbert's gambit, hold US-listed VOO/VTI for maximum tax efficiency.
- Non-registered: Unhedged. Avoid hedged funds here because tracking error creates unpredictable distributions.
- Short-term goal (under 5 years): Hedged makes sense to lock in the exchange rate. Or just hold a HISA ETF.
- Already retired and spending in CAD: A small allocation to hedged ETFs can reduce sequence-of-returns risk on the foreign sleeve.
What about partial hedging?
A few investors split the difference by holding both versions - say, 70 percent VFV and 30 percent VSP - to dampen FX swings without giving up the full long-run advantage. In practice, this adds rebalancing complexity for little real benefit. If you are comfortable buying VSP at all, just hold the asset allocation that suits your horizon and use a tool like the Wealth Rebalancer to keep targets in line as markets move.
For a deeper look at the building blocks involved, see our guides on VOO vs VFV, how to invest in the S&P 500 from Canada, and the XAW vs VXC comparison for the global ex-Canada sleeve.
Frequently asked questions
Should I buy VFV or VSP for the S&P 500?
For a long-term Canadian investor, VFV (unhedged) is the better choice in almost every case. Over 10+ years, the 0.3 to 0.7 percent annual hedging drag costs you tens of thousands of dollars on a typical RRSP balance, and the unhedged version gives you a natural USD cushion during equity drawdowns.
Are hedged ETFs more tax-efficient?
Generally no. Hedged ETFs often distribute capital gains from rolling forward contracts, which can be less tax-efficient than the simple dividend stream of an unhedged ETF. Inside a TFSA or RRSP this is moot, but in a non-registered account hedged ETFs can create lumpy T3 distributions you did not expect.
What is the real annual cost of currency hedging in Canada?
The published MER is identical for most hedged and unhedged pairs (around 0.09 percent for VFV/VSP). The hidden cost shows up as tracking error and typically runs 0.30 to 0.70 percentage points per year for CAD/USD products. Over 30 years of compounding, that gap can shrink your portfolio by 15-20 percent.
Does the RRSP foreign withholding tax change my hedging decision?
No. Withholding tax is charged on dividends regardless of whether the fund is hedged. The bigger RRSP optimization is holding US-listed ETFs (like VOO instead of VFV) to avoid the 15 percent US withholding entirely. That sidesteps the hedging question completely because US-listed ETFs are inherently unhedged in USD.
Do hedged ETFs protect against all currency risk?
No. Hedged ETFs use 1-month forward contracts that are rebalanced monthly. They neutralize most of the currency move, but short-term mismatches and large mid-month swings can still leak through. Hedging is a smoothing tool, not a guarantee.
Should I switch from VFV to VSP if I am close to retirement?
Most planners say no. Even retirees typically have a 20-30 year drawdown horizon, so the long-run advantage of unhedged still applies to the bulk of the portfolio. A small allocation to hedged products (or laddered GICs) for the next 3-5 years of spending is a better way to manage near-term FX risk than flipping the entire equity sleeve to hedged.