Assessing the iShares MSCI EAFE Index ETF (CAD-Hedged) in a Rising Rate World: Currency Hedging and Global Exposure

The global financial landscape in 2025 is defined by a stark contrast: central banks, having raised interest rates aggressively to combat inflation, now face the challenge of balancing economic stability with the unintended consequences of tighter monetary policy. For investors, the iShares MSCI EAFE Index ETF (CAD-Hedged) (XIN.TO) offers a unique lens through which to analyze the interplay of currency hedging, international equity exposure, and macroeconomic shifts. This article examines how the fund's hedging strategy and its alignment with the MSCI EAFE Index have shaped its performance during recent periods of rising interest rates, and what this implies for future investment decisions.

The Dual Forces: Currency Hedging and EAFE Exposure

The MSCI EAFE Index, which tracks large- and mid-cap equities in developed markets outside the U.S. and Canada, has long been a proxy for global diversification. However, its performance during rising rate environments is not purely a function of equity fundamentals. Currency dynamics—particularly the impact of hedging—play a critical role. The CAD-hedged variant of the iShares EAFE ETF (XIN.TO) aims to mitigate the volatility of the Canadian dollar against foreign currencies, a feature that becomes especially relevant when interest rates diverge across regions.

Historical data from 2015 to 2025 reveals a compelling narrative. During this period, the MSCI EAFE Currency Hedged Index outperformed its unhedged counterpart by approximately 2.8% annually, driven by a combination of U.S. dollar strength and favorable interest rate differentials. For instance, the hedged index returned 121% over the decade, compared to 69% for the unhedged version. This outperformance was not merely a function of higher returns but also lower volatility: the hedged index exhibited an annualized volatility of 12.4%, versus 15.1% for the unhedged index. The Sharpe ratio of the hedged index (0.55) further underscores its superior risk-adjusted performance.

Rising Rates and the Hedging Premium

The period from 2022 to 2025, marked by aggressive rate hikes by the U.S. Federal Reserve and other central banks, provides a case study in how currency hedging can amplify returns. As the U.S. dollar strengthened against the euro, yen, and other major currencies, the CAD-hedged EAFE ETF benefited from two key mechanisms:

1. Currency Carry: By hedging foreign currency exposure into CAD, the fund effectively locked in the interest rate differential between Canada and other developed markets. For example, during 2022–2023, when the Bank of Canada raised rates more aggressively than the European Central Bank, the hedging strategy generated a positive carry of approximately 140 basis points annually.
2. Volatility Reduction: The hedged ETF's drawdowns were consistently less severe than those of its unhedged counterpart. In 2022, the hedged index fell by -14.51%, while the unhedged version dropped -28.59%. This resilience was critical in preserving capital during periods of global uncertainty, such as the war in Ukraine and energy market shocks.

Structural Challenges and Strategic Implications

Despite these advantages, the CAD-hedged EAFE ETF is not without its limitations. The fund's exposure to developed markets—many of which face structural headwinds like aging populations and low productivity growth—means its long-term returns are inherently constrained. For instance, Japan and Europe, which constitute a significant portion of the MSCI EAFE Index, have historically underperformed U.S. equities during periods of high interest rates. This was evident in 2022–2023, when the S&P 500 outperformed the EAFE Index by a wide margin.

Moreover, the effectiveness of currency hedging depends on the trajectory of interest rates. As central banks begin to normalize rates, the carry benefits of hedging may diminish. Investors must also weigh the costs of hedging—typically reflected in higher expense ratios—against the potential gains. The iShares EAFE ETF (CAD-Hedged) has an expense ratio of 0.32%, which, while reasonable, may erode returns in environments where currency movements are less predictable.

Investment Advice: Balancing Hedging and Diversification

For investors seeking to navigate the current macroeconomic environment, the CAD-hedged EAFE ETF offers a compelling but nuanced proposition. Here are three key considerations:

1. Use Hedging as a Risk-Management Tool: While hedging may not always enhance returns, it significantly reduces downside risk during periods of currency volatility. For Canadian investors, this is particularly relevant as the CAD's sensitivity to commodity prices and global trade cycles can amplify portfolio fluctuations.
2. Diversify Beyond EAFE: The EAFE Index's underperformance relative to U.S. equities during recent rate hikes highlights the importance of geographic diversification. Investors should consider complementing EAFE exposure with emerging markets or sector-specific ETFs to capture growth opportunities in a shifting global economy.
3. Monitor Interest Rate Differentials: The future performance of the CAD-hedged EAFE ETF will hinge on the divergence between Canadian and international interest rates. As the Bank of Canada and other central banks adjust their policies, the cost-benefit analysis of hedging will evolve. Regularly reviewing these dynamics is essential for maintaining an optimal portfolio.

Conclusion

The iShares MSCI EAFE Index ETF (CAD-Hedged) exemplifies the complex interplay between currency hedging, equity exposure, and macroeconomic forces. While its performance during recent rate hikes has been marked by resilience and risk mitigation, its long-term success will depend on the ability of developed markets to adapt to a higher-rate world. For investors, the key takeaway is clear: in an era of global uncertainty, strategic use of hedging and a diversified approach to international equities can provide both protection and opportunity. As central banks continue to navigate the delicate balance between inflation control and economic growth, the lessons from the EAFE ETF's journey will remain relevant for years to come.