FUND FLAVOUR
April 2012

Spreading its wings…

As the name suggests, global funds invest in global stocks and/or mutual funds (that in turn invest in global markets). So what do global funds offer Indian investors?

The biggest advantage is that you get opportunities to invest at a global level. Global mutual funds take advantage of markets throughout the world. If one market performs poorly, global mutual funds can choose to move assets, investing in markets with more potential. Not all the markets of the world move in one pack, so a downswing in a country's market can be well taken care of by gains in the others. So, it is essential to have diversification in different markets across the world. Global funds have opened a window to international asset markets for Indian investors. They have made it easier for you to diversify your portfolios (and in this way de-risk them) beyond the conventional domestic equity and debt avenues across sectors, across countries, and across geographies. By being invested in domestic markets, you already have a flavour of emerging markets. Ideally, you want to diversify by investing in other markets (like developed markets for instance) that behave differently vis-a-vis emerging markets.

…far and wide

You can look at international funds to reduce risks and enhance returns via diversification across geographies, currencies and different market conditions. Currently, 17 fund houses in India offer this choice. These funds are available across developed and emerging markets as well as under different fund management styles, viz. active and passive management.

Investors beware!

Having said that, investing in global funds has its fair share of risks.

International funds are exposed to country-specific, economic and geo-political risks in the countries they invest in. Some international funds invest only in one country. Hence any political or economic problems in that country will have a negative impact on the performance of these funds. For e.g., the economic dishevel caused by a tsunami and nuclear crisis in Japan in March 2011 impacted its market severely compared to other global markets.

There is currency risk, which means that if the rupee rises in value against the dollar, your rupee return from your international fund will be lowered. Of course, the flip side is that if the rupee falls in value, international returns become more attractive in rupee terms. Underlying securities in international funds or investments in mother funds are made in foreign currency, which makes them vulnerable to the currency risk. This was seen in recent times when the dollar appreciated sharply against most emerging market currencies with the domestic rupee reaching historic lows.

Since overseas investments involve lot of money transfers with various kinds of charges and stamp duties to be paid as per the country or market specific requirements, the fund management charges for global funds are usually high. In certain cases, hidden expenses are also involved. Some global funds are feeder funds - they invest their corpus in their parent fund abroad, which, in turn, would invest in global equities. This three-tier structure adds to the expense quotient of your fund, which can eat into your yield in a big way in the long term. For instance, Black Rock World Gold Fund - the parent fund of DSP World Gold Fund - has an initial charge of 5% and annual management fee of 1.75%. This is over and above what your domestic fund charges you. Over a period of time, higher expenses can and will erode returns significantly.

Global funds are treated as non-equity funds and taxed accordingly. Thus, long-term capital gain would be taxed at 10% without indexation or at 20% with indexation. Short-term capital gain would be taxed as per your tax slab. Thus, it could be as high as 30%. But, if your fund has a mandate to invest at least 65% in Indian equities and the rest in foreign securities, it will be at par with Indian equity funds and treated accordingly for tax purposes.

If you are going for a global fund-of-fund, your fund-selection task can be easier as these funds invest their corpus in their parent global funds that have been in existence for some time. You can track the performance of the parent funds for the last three to five years (wherever possible) and benchmark the same against global indices like MSCI World Index or MSCI EMEA. Thereafter, you can take the final call on whether to invest in it or not. In the Indian context, this is a relatively new area. So, most of these funds do not have much of a track record.

Barring a few global funds in India, others have very low corpus inspite of the fact that they have been in existence for a few years now. The top mutual fund players, HDFC and Reliance, have not ventured to launch global funds.

A mixed bag

According to Value Research data, of the 28 global funds at present, only three can boast of double-digit returns over the past one year. 10 funds have earned single digit returns and 11 funds negative returns during the same period. Four funds have not completed one year since launch. The best returns offered by international funds over a three year period was by AIG World Gold Fund and DSPBR World Gold Fund with 33.83% and 28.85% respectively. The returns of the remaining eight international funds that figured among the top 10 funds ranged from –0.48% by HSBC Emerging Markets to 9.47% by Franklin Asia Equity. According to Value Research, of the 28 global funds, nearly a third has an expense ratio of nearly 2.5%, the maximum that is allowed.

Developed market equities (indices) performed better than emerging market equities in the bear phase (2008 and 2011) while emerging market equities outperformed in a bull phase. Thus, global diversification of one's portfolio through a selection of international equity mutual funds not only reduces risks in a bear phase but also enhances returns in a bull phase. These funds are professionally managed by Indian registered mutual funds that directly invest in foreign securities or overseas mutual funds (which in turn invest in foreign securities). For investors who want to protect their portfolio from market uncertainty, exposure to developed market indices via mutual funds provides an ideal hedge. Similarly, investors looking for higher returns can look at investing in emerging markets/ high-growth economies like India. Developed market funds gave higher returns or declined less in the volatile periods (2011 and 2008), while emerging market indices scored higher in the bull period (2007, 2009, 2010 and 2012 YTD).

If you are a new investor, global funds may not be for you because of the risks involved in them. You should have an India portfolio consisting of well-managed funds with established track records and investment processes. Only then must you invest in global funds. Put simply, global funds must not be considered as a stand-alone investment. Rather they must form part of a portfolio. Since global funds must be considered primarily for the purpose of diversification and asset allocation, they should not form a large chunk of your portfolio. According to a survey, the best policy for investment is to have a 70% domestic investment and a 30% international diversified funds investment. The survey reveals that this investment strategy is better than having a 100% domestic investment portfolio or a 100% international exposure in terms of risk exposure and return on the capital.