The arithmetic is direct. Return measured in home currency approximately equals local currency return plus the currency movement. Where the home currency weakens, foreign assets are worth more when translated, and where it strengthens the reverse applies. The relationship is mathematically simple, and its practical weight is routinely underestimated, since most quotations and commentary discuss local currency returns. The short-run magnitude can be very large. Annual movements exceeding ten per cent between major currency pairs are unremarkable, and median annual equity returns fall in a similar range. In any given year, therefore, currency movement can fully offset or double what a market delivered, with no connection to how the underlying businesses performed. The long-run picture differs.
Across decades, the cumulative effect of currency movement is usually smaller than the cumulative effect of equity returns. Exchange rates display some mean reversion around purchasing power parity, while equity returns compound. This makes currency closer to a source of volatility than a source of return over long horizons. Whether to hedge is a real decision with no universally correct answer. Hedging removes the currency movement at a cost, and that cost is approximately the short-term interest rate differential between the two currencies. Where domestic rates sit well below foreign rates, the cost of hedging can be considerable and erodes a meaningful share of returns when accumulated. Asset class affects the decision.
Most research concludes that currency risk on foreign bonds should be hedged. Bond volatility is far smaller than currency volatility, and leaving it unhedged allows currency to dominate the risk of the position. Views on foreign equities are more divided, since equity volatility is already large and the marginal currency contribution is proportionally smaller. A further relationship is frequently overlooked. Currency movements correlate with the earnings of companies in the affected market. In export-oriented economies, domestic currency weakness usually improves corporate earnings, which partly offsets the translation loss a foreign holder experiences. In markets driven by domestic demand and imports, weakness damages earnings and the currency simultaneously, so both move the same way.
For investors based in Taiwan the question takes a specific form. Holding dollar assets means bearing the movement of the local currency against the dollar, and that rate has had long range-bound periods as well as clearly trending ones. Which historical stretch is used as a reference produces quite different conclusions, and this deserves attention when setting long-run assumptions. The more robust approach begins with measurement. Calculating how much of the return on foreign positions over recent years came from the assets and how much from currency is possible in most brokerage reporting. Once the actual proportion is known, a discussion about hedging has a foundation, and most people make the decision without ever having established that figure.
One further consideration concerns liabilities rather than assets. Somebody who expects to spend in a foreign currency, whether through education, property or retirement abroad, holds a future obligation in that currency. For them, unhedged exposure to it reduces risk rather than adding to it, and the standard analysis reverses. The correct treatment depends on what the money is eventually for. Practically, hedged and unhedged versions of the same fund are widely available, which makes this an implementable decision rather than a theoretical one. The difference between them accumulates visibly over several years. Comparing the two series for a market already held is the most direct way to see what currency has contributed.