USD funds for a euro investor: what the dollar does to your return

A euro investor in a dollar fund holds two positions: the fund and the dollar. Every capital call and every distribution is converted at the exchange rate of the day it is paid, so the return in euros is a different number from the one in the fund's report, and it can be higher or lower. In the example below the fund reports a net IRR of 12.2 per cent in dollars; the same payments give 10.0 per cent in euros. Hedging a commitment with forward contracts is not realistic for a private LP. Holding the dollars for the next calls is.

Every payment has its own exchange rate

Say you committed USD 300,000 to a US venture fund in 2021. The payments below are invented; the exchange rates are the ECB's euro reference rates for those days, in dollars per euro.

In dollars you paid in 270,000 and hold 410,000 of distributions and NAV: a TVPI of 1.52x and a net IRR of 12.2 per cent. In euros you paid in 253,474 and hold 355,945: a TVPI of 1.40x and an IRR of 10.0 per cent.

Why is the fund's IRR not yours?

The fund did nothing different. The gap comes from one line: the largest call fell on 27 September 2022, when a euro bought less than a dollar. USD 120,000 cost EUR 124,430 that day. At today's reference rate of 1.1770 the same call would cost EUR 101,954. You bought most of your dollars when they were most expensive, and the fund's value is now translated back at a much weaker dollar.

You did not choose that date. The manager calls when a deal closes. An investor whose big calls fell in 2021 and whose distributions arrive at parity would see the opposite: a euro return above the dollar return. Over a fund's life of ten years and more the currency result is a second return stream that has nothing to do with the manager's skill, and it is not small: two points of IRR a year, over the years this fund has run, is the difference between a TVPI of 1.52x and one of 1.40x.

This is also why the IRR in the report cannot simply be copied into a euro portfolio. As we argued in the piece on IRR, TVPI and DPI, the only IRR that describes your investment comes from your own dated cash flows. For a foreign-currency fund that means your cash flows in euros.

Which exchange rate belongs to a payment?

The ECB publishes its euro foreign exchange reference rates on every working day at around 16:00 CET, based on a daily concertation between central banks at around 14:10 CET. The ECB states that they are for information only and discourages using them for transactions. They are mid rates. No bank will sell you dollars at them.

For a record that is exactly their use. A reference rate fixed on the value date makes the conversion reproducible: anyone can look up 27 September 2022 and arrive at the same euro amount. Two rules follow.

First, a payment keeps the rate of its day. If history is reconverted at today's rate, the paid-in capital of 2022 shrinks or grows every morning, and so do the DPI and IRR of a fund that has not changed. Only the NAV, which is a value and not a payment, moves with the current rate. In the example, the NAV of USD 310,000 was EUR 269,612 at the end of March and is EUR 263,381 at today's rate. The fund reported nothing in between.

Second, if you actually exchanged euros to meet a call, the euros your bank debited are the truth for that payment, and the gap to the reference rate is what the conversion cost you. It is worth looking at that gap once. On a few hundred thousand dollars over a fund's life, a bank margin of one per cent is a real amount, and it is negotiable.

Valued follows the first rule: every amount keeps its currency and is converted at the ECB reference rate of its value date, with both figures side by side.

The unfunded commitment is a dollar liability

After three calls, USD 30,000 of the commitment is still open. At today's rate that is EUR 25,489. At the rate of September 2022 it would be EUR 31,107. On a commitment ten times the size, the same swing is EUR 56,000 of liquidity you either need or do not need.

A liquidity plan in euros should therefore carry the open dollar commitments in dollars, convert them at the current rate, and add a margin. Between the first half of 2021 and the autumn of 2022 the euro lost about a fifth against the dollar. A reserve that only just covers the unfunded commitment at today's rate does not cover it after a move like that.

Is hedging a commitment realistic?

A forward contract fixes a rate for an amount on a date. A capital call has neither. The amount is whatever the next deal needs, and the notice is short; ten business days is the common standard. A forward for "about USD 60,000, some time next year" does not exist.

Hedging the NAV instead runs into a different problem. The NAV is an estimate that arrives a quarter late, and nobody knows when it will turn into cash. A forward has to be settled or rolled at fixed dates, in cash. If the dollar rises, the hedge loses money that must be paid now, against a gain on a fund stake that cannot be sold. Institutions carry that with credit lines and a treasury desk. For a private LP it swaps a currency risk for a liquidity risk, which is the worse one to have.

There is also the question of what is being hedged. The fund's currency is the currency of its accounts. A dollar fund that owns European companies, or a euro fund whose companies sell mostly in the United States, has an economic exposure that the reporting currency does not show.

What a private investor can do is simpler.

• Hold the dollars for the calls expected over the next one to two years, in a dollar account or a short-dated dollar instrument. That fixes the euro cost of those calls on the day you buy the dollars, without a derivative.
• Keep dollar distributions in dollars as long as dollar calls are still to come. Converting back and forth pays the bank twice.
• Decide the dollar share for the whole portfolio. Someone who holds a global equity ETF already owns a large dollar position; the fund commitments add to it. We looked at that effect on listed holdings in the review of the first half of 2025.
• Spread commitments across vintages. Calls then fall across many exchange rates instead of one.

Dollar balances have tax consequences of their own for a German investor; that is a question for your tax adviser, and this article is not tax advice.

None of this removes the currency result. It makes it a position you chose. The step that costs nothing is to compute, for each dollar fund you hold, the IRR in both currencies from your own payments. If the two differ by two points, as in the example, you know how much of your return so far was the manager and how much was the date of a call.