An investor who buys shares listed in another country takes on two distinct risks in a single transaction. The company can trade well while the holding still loses value measured in the investor's own currency.
Every foreign holding is two positions
Buying a share priced in another currency requires converting money first. The investor therefore holds that currency for as long as the position is open, whether or not this was the intention.
The return that lands in a home-currency account is the share price move combined with the exchange rate move. Either can be positive while the other is negative.
This is why two investors in different countries can hold the same stock over the same period and report different results. Neither is mismeasuring anything.
Why the currency leg can swamp the equity leg
Exchange rates between major economies can move several points over a few months when interest rate expectations shift. Equity indices frequently move less than that over the same window.
For a fund holding many foreign markets, the aggregate currency effect can therefore be the largest single contributor to a quarterly result. Stock selection is left looking almost irrelevant.
The effect is symmetric rather than a permanent drag. A currency that weakens against a portfolio's holdings one year often strengthens the next, which is why long-run figures show a smaller gap.
How hedging separates the two decisions
A currency hedge uses forward contracts to lock the conversion rate for a future date, so the position tracks the foreign share price alone. The exposure is neutralised rather than removed from the world.
Hedging is not free. The forward price reflects the interest rate difference between the two currencies, so a hedge into a lower-rate currency carries an ongoing cost that shows up as reduced return.
Why exporters and domestic firms respond differently
A weaker local currency raises the home-currency value of an exporter's foreign sales, which can lift its share price. Part of the currency loss to a foreign investor is offset by the equity gain.
A firm selling only domestically and importing its inputs sees the opposite. Its costs rise while its revenue is unchanged, so the currency loss and the equity loss compound rather than cancel.
Index composition therefore determines how tightly a market's returns and its currency are linked. Commodity-exporting markets tend to show the strongest connection.
Reading a foreign index return correctly
A headline index figure quoted in the local press is a local-currency number. It answers a question about that market's companies, not about what a foreign holder earned.
Comparisons across markets need every figure converted to one currency before they mean anything. Data providers publish both versions for this reason, and the gap between them is often wide.