How do euro hedged index funds work?
"When you invest in an S&P500 index fund that is priced in USD, the only major risk you bear is the risk associated with the equity that comprises the index, since both the equities and the index fund are priced in USD. The fund in your question, however, is priced in EUR. For a fund like this to match the performance of the S&P500, which is priced in USD, as closely as possible, it needs to hedge against fluctuations in the EUR/USD exchange rate. If the fund simply converted EUR to USD then invested in an S&P500 index fund priced in USD, the EUR-priced fund may fail to match the USD-priced fund because of exchange rate fluctuations. Here is a simple example demonstrating why hedging is necessary. I assumed the current value of the USD-priced S&P500 index fund is 1,600 USD/share. The exchange rate is 1.3 USD/EUR. If you purchase one share of this index using EUR, you would pay 1230.77 EUR/share:  If the S&P500 increases 10% to 1760 USD/share and the exchange rate remains unchanged, the value of the your investment in the EUR fund also increases by 10% (both sides of the equation are multiplied by 1.1):  However, the currency risk comes into play when the EUR/USD exchange rate changes. Take the 10% increase in the price of the USD index occurring in tandem with an appreciation of the EUR to 1.4 USD/EUR:  Although the USD-priced index gained 10%, the appreciation of the EUR means that the EUR value of your investment is almost unchanged from the first equation. For investments priced in EUR that invest in securities priced in USD, the presence of this additional currency risk mandates the use of a hedge if the indexes are going to track. The fund you linked to uses swap contracts, which I discuss in detail below, to hedge against fluctuations in the EUR/USD exchange rate. Since these derivatives aren't free, the cost of the hedge is included in the expenses of the fund and may result in differences between the S&P500 Index and the S&P 500 Euro Hedged Index.  Also, it's important to realize that any time you invest in securities that are priced in a different currency than your own, you take on currency risk whether or not the investments aim to track indexes. This holds true even for securities that trade on an exchange in your local currency, like ADR's or GDR's. I wrote an answer that goes through a simple example in a similar fashion to the one above in that context, so you can read that for more information on currency risk in that context.  There are several ways to investors, be they institutional or individual, can hedge against currency risk. iShares offers an ETF that tracks the S&P500 Euro Hedged Index and uses a over-the-counter currency swap contract called a month forward FX contract to hedge against the associated currency risk. In these contracts, two parties agree to swap some amount of one currency for another amount of another currency, at some time in the future. This allows both parties to effectively lock in an exchange rate for a given time period (a month in the case of the iShares ETF) and therefore protect themselves against exchange rate fluctuations in that period.  There are other forms of currency swaps, equity swaps, etc. that could be used to hedge against currency risk. In general, two parties agree to swap one quantity, like a EUR cash flow, payments of a fixed interest rate, etc. for another quantity, like a USD cash flow, payments based on a floating interest rate, etc. In many cases these are over-the-counter transactions, there isn't necessarily a standardized definition.  For example, if the European manager of a fund that tracks the S&P500 Euro Hedged Index is holding euros and wants to lock in an effective exchange rate of 1.4 USD/EUR (above the current exchange rate), he may find another party that is holding USD and wants to lock in the respective exchange rate of 0.71 EUR/USD. The other party could be an American fund manager that manages a USD-price fund that tracks the FTSE. By swapping USD and EUR, both parties can, at a price, lock in their desired exchange rates.  I want to clear up something else in your question too. It's not correct that the ""S&P 500 is completely unrelated to the Euro."" Far from it. There are many cases in which the EUR/USD exchange rate and the level of the S&P500 index could be related. For example: Troublesome economic news in Europe could cause the euro to depreciate against the dollar as European investors flee to safety, e.g. invest in Treasury bills. However, this economic news could also cause US investors to feel that the global economy won't recover as soon as hoped, which could affect the S&P500.  If the euro appreciated against the dollar, for whatever reason, this could increase profits for US businesses that earn part of their profits in Europe. If a US company earns 1 million EUR and the exchange rate is 1.3 USD/EUR, the company earns 1.3 million USD. If the euro appreciates against the dollar to 1.4 USD/EUR in the next quarter and the company still earns 1 million EUR, they now earn 1.4 million USD. Even without additional sales, the US company earned a higher USD profit, which is reflected on their financial statements and could increase their share price (thus affecting the S&P500). Combining examples 1 and 2, if a US company earns some of its profits in Europe and a recession hits in the EU, two things could happen simultaneously. A) The company's sales decline as European consumers scale back their spending, and B) the euro depreciates against the dollar as European investors sell euros and invest in safer securities denominated in other currencies (USD or not). The company suffers a loss in profits both from decreased sales and the depreciation of the EUR.  There are many more factors that could lead to correlation between the euro and the S&P500, or more generally, the European and American economies. The balance of trade, investor and consumer confidence, exposure of banks in one region to sovereign debt in another, the spread of asset/mortgage-backed securities from US financial firms to European banks, companies, municipalities, etc. all play a role.  One example of this last point comes from this article, which includes an interesting line: Among the victims of America’s subprime crisis are eight municipalities in Norway, which lost a total of $125 million through subprime mortgage-related investments. Long story short, these municipalities had mortgage-backed securities in their investment portfolios that were derived from, far down the line, subprime mortgages on US homes. I don't know the specific cities, but it really demonstrates how interconnected the world's economies are when an American family's payment on their subprime mortgage in, say, Chicago, can end up backing a derivative investment in the investment portfolio of, say, Hammerfest, Norway."
The market is efficient, but it is not perfectly efficient. There are entities out there that consistently, legitimately, and significantly outperform the market because of asymmetric information (not necessarily insider trading) and their competitive advantage (access to data and proprietary, highly sophisticated models)*. I say this despite most hedge funds performing worse than their respective benchmarks. For most people (even very smart people) it makes a lot of sense to invest in index funds with a reasonable asset allocation (based on desired volatility, tax situation, rebalancing methods etc.).   * The usual example that is cited is RT's  Medallion Fund because it has enjoyed quite dramatic returns. Other groups that have been successful include Citadel and Soros Fund Management. An index fund is just copying the definition of an index. The group that defines the index determines how to weight the different parts of the index. The index fund just makes sure they invest the same way the index creator wants.  Think of a non-investment scenario. A teacher can grade tests, quizzes, homework, in-class assignments, research papers. They decide how much weight to give each category and how much weight to give each part of each category. when a student wants to see how they are doing they take the information in the syllabus, and generate a few formulas in a spreadsheet to calculate their current grade. They can also calculate what they need to get on the final exam to get the grade they want. "Yes, I'm a big picture guy.  Like when the central banks opened unlimited short term lines recently the first thing I thought was ""now hedge funds can short the euro with impunity!""  So, short bets on the euro became a no brainer even as the market was perversely celebrating the announcement with a euro rally.  Almost as if they have no idea how the bigger picture works.  As if all liquidity is created equally.  All it meant to me was that European banks would not have to call in the lines of credit they extend to hedge funds for THREE YEARS.  That is enough time to crash the euro, hold a funeral and dance on the grave.  It is just musical chairs over there.  All the banks know the EU is coming for them an they all want to be in the right capital position to survive the banhammer.  They'll sell out the euro to get there.  I think I'm a bit too jaded for Graham style fundamental analysis.  Then again I do use strong companies as my preferred trading vehicles.  So, maybe I do a hybrid." You will have to rebalance every time your Boolean Buy flag is true. You buy 20% of each fund then next week you have to sell down to 10% of your first 5 funds and buy 10% of the second 5. Hedge funds are typically just funds structured and operated in a way that make them exempt from various securities regulations, most notably the Investment Company Act of 1940 and the Investment Advisers Act of 1940.  This allows them to operate freely of restrictions on traditional fund such as those related to management compensation, public disclosures, investor liquidity, and portfolio concentration and use of leverage.  In order to achieve this, hedge funds are typically open only to a limited number of wealthy or sophisticated investors and are restricted in how and to whom they can advertise. "The amount, reliability and frequency of dividends paid by an ETF other than a stock, such as an index or mutual fund, is a function of the agreement under which the ETF was established by the managing or issuing company (or companies), and the ""basket"" of investments that a share in the fund represents.  Let's say you invest in a DJIA-based index fund, for instance Dow Diamonds (DIA), which is traded on several exchanges including NASDAQ and AMEX. One share of this fund is currently worth $163.45 (Jan 22 2014 14:11 CDT) while the DJIA itself is $16,381.38 as of the same time, so one share of the ETF represents approximately 1% of the index it tracks. The ETF tracks the index by buying and selling shares of the blue chips proportional to total invested value of the fund, to maintain the same weighted percentages of the same stocks that make up the index. McDonald's, for instance, has an applied weight that makes the share price of MCD stock roughly 5% of the total DJIA value, and therefore roughly 5% of the price of 100 shares of DIA. Now, let's say MCD issued a dividend to shareholders of, say, $.20 per share. By buying 100 shares of DIA, you own, through the fund, approximately five MCD shares, and would theoretically be entitled to $1 in dividends. However, keep in mind that you do not own these shares directly, as you would if you spent $16k buying the correct percentage of all the shares directly off the exchange. You instead own shares in the DIA fund, basically giving you an interest in some investment bank that maintains a pool of blue-chips to back the fund shares. Whether the fund pays dividends or not depends on the rules under which that fund was set up. The investment bank may keep all the dividends itself, to cover the expenses inherent in managing the fund (paying fund management personnel and floor traders, covering losses versus the listed price based on bid-ask parity, etc), or it may pay some percentage of total dividends received from stock holdings. However, it will virtually never transparently cut you a check in the amount of your proportional holding of an indexed investment as if you held those stocks directly. In the case of the DIA, the fund pays dividends monthly, at a yield of 2.08%, virtually identical to the actual weighted DJIA yield (2.09%) but lower than the per-share mean yield of the ""DJI 30"" (2.78%). Differences between index yields and ETF yields can be reflected in the share price of the ETF versus the actual index; 100 shares of DIA would cost $16,345 versus the actual index price of 16,381.38, a delta of $(36.38) or -0.2% from the actual index price. That difference can be attributed to many things, but fundamentally it's because owning the DIA is not the exact same thing as owning the correct proportion of shares making up the DJIA. However, because of what index funds represent, this difference is very small because investors expect to get the price for the ETF that is inherent in the real-time index." Currency hedge means that you are somewhat protected from movements in currency as your investment is in gold not currency. So this then becomes less speculative and concentrates more on your intended investment.  EDIT The purpose of the GBSE ETF is aimed for investors living in Europe wanting to invest in USD Gold and not be effected by movements in the EUR/USD. The GBSE ETF aims to hedge against the effects of the currency movements in the EUR/USD and more closely track the USD Gold price. The 3 charts below demonstrate this over the past 5 years.    So as is demonstrated the performance of the GBSE ETF closely matches the performance of the USD Gold price rather than the EUR Gold price, meaning someone in Europe can invest in the fund and get the appropriate similar performance as investing directly into the USD Gold without being affected by currency exchange when changing back to EUR. This is by no way speculative as the OP suggests but is in fact serving the purpose as per the ETF details. The biggest hedge funds seem to be copying the large mutual fund company strategy.  Launch many funds.  Take positions with high beta to the sector or asset class that is the focus of the fund.  Wait and see which asset classes outperform. (For Och-Ziff: Their massive bullish bet on credit!)  Promote the outperforming funds and their portfolio manager to gullible investors. There is no evidence that QE had a negative effect on hedge fund alpha. If you claim, that hedge funds are not able to deliver positive risk adjusted return in up markets - this is wrong assumption. It's been proven, that with the leverage they get, hedge funds can perform better in bullish markets.  We recently investigated the performance of 180 Danish funds in the past two decades. We found no evidence that they could outperform their relative benchmarks. Not even that, but we also assumed zero costs for investor, where in reality costs can range from 2 to 5%. Danish funds not only fail in term of positive risk adjusted return, but they also struggle to cover their costs.  TL:DR The lover the cost - the higher the return. Evidence says - Go passive! The currency market, more often referred as Forex or FX, is the decentralized market through which the currencies are exchanged. To trade currencies, you have to go through a broker or an ECN. There are a lot's of them, you can find a (small) list of brokers here on Forex Factory. They will allow you to take very simple position on currencies. For example, you can buy EUR/USD. By doing so, you will make money if the EUR/USD rate goes up (ie: Euro getting stronger against the US dollar) and lose money if the EUR/USD rate goes down (ie: US dollar getting stronger against the Euro). In reality, when you are doing such transaction the broker: borrows USD, sell it to buy EUR, and place it into an Euro account. They will charge you the interest rate on the borrowed currency (USD) and gives you the interest and the bought currency (EUR). So, if you bought a currency with high interest rate against one with low interest rate, you will gain the interest rate differential. But if you sold, you will lose the differential. The fees from the brokers are likely to be included in the prices at which you buy and sell currencies and in the interest rates that they will charge/give you. They are also likely to gives you big leverage to invest far more than the money that you deposited in their accounts. Now, about how to make money out of this market... that's speculation, there are no sure gains about it. And telling you what you should do is purely subjective. But, the Forex market, as any market, is directed by the law of supply and demand. Amongst what impacts supply and demands there are: Also, and I don't want to judge your friends, but from experience, peoples are likely to tell you about their winning transaction and not about their loosing ones. This is great. Thanks! So, just assuming a fund happened to average out to libor plus 50 for a given year, would applying that rate to the notional value of the index swaps provide a reasonable estimate of the drag an ETF investor would experience due to the cost associated with the index swaps?  For instance, applying this to the hypothetical I linked to in the original question, they assumed fund assets of $100M with 2x leverage achieved through $85M of S&amp;P500 stocks, $25M of S&amp;P500 futures, and a notional value of the S&amp;P500 swaps at $90M. So the true costs to an ETF investor would be: expense ratio + commissions on the $85M of S&amp;P500 holdings + costs associated with $25M of futures contracts + costs associated with the $90M of swaps? And the costs associated with the $90M of swaps might be roughly libor plus 50? I will just try to come up with a totally made up example, that should explain the dynamics of the hedge. Consider this (completely made up) relationship between USD, EUR and Gold: Now lets say you are a european wanting to by 20 grams of Gold with EUR. Equally lets say some american by 20 grams of Gold with USD. Their investment will have the following values: See how the europeans return is -15.0% while the american only has a -9.4% return? Now lets consider that the european are aware that his currency may be against him with this investment, so he decides to hedge his currency. He now enters a currency-swap contract with another person who has the opposite view, locking in his EUR/USD at t2 to be the same as at t0. He now goes ahead and buys gold in USD, knowing that he needs to convert it to EUR in the end - but he has fixed his interestrate, so that doesn't worry him. Now let's take a look at the investment: See how the european now suddenly has the same return as the American of -9.4% instead of -15.0% ? It is hard in real life to create a perfect hedge, therefore you will most often see that the are not totally the same, as per Victors answer - but they do come rather close. In your other question about these funds you quoted two very different yields for them. That pretty clearly says they are NOT tracking the same index. "i know that hedge funds shouldn't be compared with index funds. they do different things. they serve different functions. but when the headline is they are reporting big gains, and then they report that ""Ken Griffin’s main Wellington and Kensington funds at Citadel rose almost 7 percent."" YTD, and ""Andreas Halvorsen’s Viking and an equity-focused quantitative fund at Renaissance are up more than 9 percent this year through July"" as reporting ""Big Gains"" it's a little silly when an index fund like SCHB is up 10.7% YTD with an ER of 0.03." Here is a simple example of how daily leverage fails, when applied over periods longer than a day. It is specifically adjusted to be more extreme than the actual market so you can see the effects more readily. You buy a daily leveraged fund and the index is at 1000. Suddenly the market goes crazy, and goes up to 2000 - a 100% gain! Because you have a 2x ETF, you will find your return to be somewhere near 200% (if the ETF did its job). Then tomorrow it goes back to normal and falls back down to 1000. This is a fall of 50%. If your ETF did its job, you should find your loss is somewhere near twice that: 100%. You have wiped out all your money. Forever. You lose. :) The stock market does not, in practice, make jumps that huge in a single day. But it does go up and down, not just up, and if you're doing a daily leveraged ETF, your money will be gradually eroded. It doesn't matter whether it's 2x leveraged or 8x leveraged or inverse (-1x) or anything else. Do the math, get some historical data, run some simulations. You're right that it is possible to beat the market using a 2x ETF, in the short run. But the longer you hold the stock, the more ups and downs you experience along the way, and the more opportunity your money has to decay. If you really want to double your exposure to the market over the intermediate term, borrow the money yourself. This is why they invented the margin account: Your broker will essentially give you a loan using your existing portfolio as collateral. You can then invest the borrowed money, increasing your exposure even more. Alternatively, if you have existing assets like, say, a house, you can take out a mortgage on it and invest the proceeds. (This isn't necessarily a good idea, but it's not really worse than a margin account; investing with borrowed money is investing with borrowed money, and you might get a better interest rate. Actually, a lot of rich people who could pay off their mortgages don't, and invest the money instead, and keep the tax deduction for mortgage interest. But I digress.) Remember that assets shrink; liabilities (loans) never shrink. If you really want to double your return over the long term, invest twice as much money.