Monday, April 07, 2008



Global/International Funds

Poise with potential !

India's mutual funds, which have given heady returns over the span of a four-year bull run at home, are now making a tactical sojourn to markets abroad chasing new themes, diversification and cushion against volatility. More liberal investment norms from the government and the growing appetite of Indian investors for money-making opportunities abroad are fuelling the funds' future strategy. They are an excellent hedging tool today when Indian markets are viciously volatile.

There are opportunities to be found on the global platform, ones that may not be located at home. India, it is argued, has a "positive, yet low correlation with most developed markets - lower than what those markets have with each other - and a low correlation with many emerging markets as well". This, in plain English, implies that we will probably move along the same track as another nation, but probably not in the same manner. Summing it all up is this sure fire logic – the Indian stock market is just about half a per cent of the world's market capitalisation. You can chew on that after you have finished reading some trivia, all of which are eminently relevant.

  • No single country accounts for over 5 per cent of the global stock market. The exceptions are the US, the UK and Japan. The US makes up well over 40 per cent; the other two are heavyweights too, though their contributions are smaller.

  • Lots of tiny countries - compared to India, they are clearly midgets in terms of size and population - like Sweden, Korea and Spain are way ahead in this respect.

  • It is not that India has been a top performer every year (even during our most memorable bull run). There are markets that have given positive returns when we have faltered. But, like history, performance repeats.

Nascent Niche

Global funds are mutual funds that invest predominantly in foreign stocks or foreign mutual funds that invest in foreign stocks. Investing in these funds allows Indian investors to access foreign markets without having to face the hassles of remitting foreign exchange. There are basically two types of global mutual funds (GMFs) - those which invest only up to 35 per cent in overseas securities, and those which invest more than 35 per cent in overseas securities, going up to 100 per cent. For convenience let us call them GMF35 and GMF100 respectively.There are three differences between the two - One, GMF35 give you a relatively less exposure to overseas markets as compared GMF100. So, the opportunity for diversification is much more in GMF100. Two, GMF35 enjoy all the tax benefits enjoyed by domestic ‘equity oriented funds,’ that is tax-free dividends and tax-free long-term capital gains. GMF100 do not. So GMF35 are more tax efficient. Three, while GMF35 can invest directly in shares of foreign companies, GMF100 cannot; these have to necessarily invest in units of foreign mutual funds. This means, other things remaining the same, the risk is lower. But given their higher percentage of investment in overseas markets, they carry higher country and currency risks. GMF100 can be further divided into two sub-types -- one, those which invest in a particular fund abroad (an Indian GMF invests in only the units of one predetermined mutual fund abroad) and two, those which invest in units of many mutual funds abroad, changing the selection from time to time. The former are often called ‘feeder funds’.That should place the different types of GMFs in proper perspective. There is nothing good or bad about them per se. They serve different needs of different investors.

The dramatis personae boasts of Principal Global Opportunities Fund, the pioneer that made its appearance in 2004, Franklin Templeton India Equity Income Fund, Fidelity International Opportunities Fund, to name a few . Nearly a dozen funds have followed suit catering to the assorted needs of the investing public evincing interest in this nacent industry…

The Legal viewpoint

The stringent restrictions that narrowed down the universe of stocks in which mutual funds could invest to just 40 has now broadened with the relaxation of norms. Mutual funds can make investments in ADRs/GDRs issued by Indian companies; equity of overseas companies listed on recognised stock exchanges overseas, foreign debt securities in the countries with fully convertible currencies, short-term and long-term instruments with highest rating. Investment will also be allowed in government securities of countries rated AAA and in units/securities issued by overseas Mutual Funds or unit trusts, which invest in the aforesaid securities or are rated and registered with overseas regulators. The Government had allowed investment of $7 billion by Indian mutual funds in various instruments overseas. Only Indian mutual funds, which are in existence for a minimum period of 10 years, would be eligible for investing in Exchange Traded Funds (ETFs) abroad. They should also follow a sub-ceiling for investing in ETFs, which prohibits them from investing more than 10 per cent of the net assets managed by them as on March 31 of each relevant year, subject to a maximum of $200 million per mutual fund.

Glorious Gamble?

Once you drill down from the top level of the economy into each country, you will find lots of wonderful businesses with strong stock performances.

Since each country offers distinct inherent strengths and each has differing growth characteristics, international investing offers diversification to investors by way of a single investment.

The yields of overseas securities are lower than that of India. Consider this. A top-rated 10-year corporate bond in the US may provide a yield of 7.5 per cent. A comparable bond in India may fetch a yield of, say, 10 per cent. Despite lower yields on bonds, investing abroad may generate higher returns, as the fund can hope to make money in the foreign exchange market and the sensitivity of the portfolio to interest rate risk can be reduced.

By and large, investors have not quite taken to global funds for a variety of reasons – Diluted diversification as a result of higher allocation to Indian equities and higher allocation to Asia/emerging markets and lack of transparency and mounting costs due to layered fund management.

Investment Nuggets …

If you are interested in investing abroad, do not just leap in the dark. International investing can be trickier than domestic investing. Most nations do not have corporate financial reporting requirements as stringent as ours and are not as stable as we are. Still, great money is being made out there. Global equity and bond markets are extremely volatile and, therefore, they signify a very high degree of risk for the uninitiated. The best option is to find top-notch Indian mutual funds focused on international investments and to invest not more than 10% of your portfolio in it.

Before investing in a global fund, you should focus on the following areas:

Expenses: The investors in these global funds have to pay higher expenses, as the global fund as well as underlying foreign fund charge a fee, that gets added up. But, an FoF reduces the transaction costs involved in shifting investments from one fund to another.
Currency risk: The rate of exchange when you buy global fund units may not be the same as the rate when you redeem the units. If the rate of exchange at the time of redemption is less than that at the time of purchase, you would incur a loss.
Country/market risk: The overall performance of a global fund can suffer if the particular country/market does not perform well.
Track record of underlying investments: It is important to check out the track record of the underlying mutual fund in which the global fund invests.
Taxation: Unlike mutual funds investing in Indian equities, global funds, which have less than 65% allocation in the Indian equity market, do not qualify for tax exemption. They attract 10% (with indexation) or 20% (without indexation) long term capital gains tax, and short term capital gains tax as steep as 30% if you are in the highest tax bracket.
Ensure that you have an adequate investment time frame of at least 3-5 years in equities and related assets.
Ideally, the Indian investor wants to diversify by investing in other markets (like developed markets for instance) that behave differently vis-à-vis emerging markets. So, go for global funds that invest across market segments.
Don’t rush into investing in global funds for whatever reasons (media hype, distributor’s persuasion). Evaluate a global fund across parameters (the investment proposition it offers, the fund’s investment processes, long-term track record across market phases, especially the downturns) by comparing it with other global funds of a similar nature.

No comments: