FUND FLAVOUR

April 2013

What is in a Mutual Fund name? A lot, actually…

A few years ago, the Securities and Exchange Commission, or SEC, passed a rule that requires mutual funds to invest 80% or more of the fund assets into securities that are compatible with the fund name. For example, the XYZ Long-Term Bond Fund would need to keep at least 80% of the fund's assets in long-term bonds or it would be in violation of this rule. That means no matter how inexpensive the stock market looked or how risky management believed long-term bonds were at any given time, they would still be required to park the money in long-term bonds.

What, then, is the precise difference between a global mutual fund and an international mutual fund? A global mutual fund invests in assets around the world including the home country. An international mutual fund invests in assets around the world excluding the home country. One lesson to take away from this is that the name of your mutual fund really does matter. International or global mutual funds expose investors’ money to foreign economies. Majority of the existing ones we have are fund of funds. This means they invest in a fund or funds (usually managed by the same mutual fund company) that invests in the target economy. Some global funds like Franklin Asian Equity, Sundaram Global Advantage are region specific whereas others like Mirae Asset China Advantage, ICICI Prudential US Bluechip Equity are country specific. Commodity based global funds like DSP BlackRock World Gold are also popular.

Why global funds have caught interest

We live in a true global economy, and only investing in the domestic markets means lot of missed opportunities. Market dynamics are different in different countries. International funds capitalize on this fact. If Indian markets did not do well in a certain period you could still have made some returns if you were invested in some other economy that did. Another fact is that certain locations have unique opportunities due to the presence of certain natural resources or some other advantage. The world economy looks good, and in general markets are giving quite decent returns on the investments. Maybe you are already aware of such growing markets around the world and maybe, would like to invest in the international market. But the fact remains that most of us do not have enough time, and expertise to do this. This is the basic reason why we invest in the mutual funds in the first place. So by investing in international mutual funds, you let the experts manage your money, and take care of the intricacies. You still are able to reap benefits that might not be available in the domestic markets. Diversification is a commonly cited benefit offered by global mutual funds. If the Indian economy is not doing well you can still benefit by having some of your money in other economies that are. Similarly even if you expose your investment to another economy that happens to work in the same tempo as the Indian economy (in technical terms a highly correlated one) you might still make gains due to currency movement. Most of the benefits listed above can be realized only when the scale of investment is large.

Why global mutual funds lack thrill

Global funds are a sort of theme funds. Unlike diversified equity funds, theme funds have a shelf life after which it would be unproductive to stay in them. Since most of them are fund of funds, management fees are charged at multiple levels and are obviously higher. When it comes to taxation, overseas funds are treated as debt funds. Being fund of funds scheme also implies that the fund managers of these global funds are not equipped to select the right shares from target economies themselves. Investors would be passively relying on fund managers of underlying schemes. Just like any other investment, international investments carry certain risk factors that are unique to such investments. Currency fluctuations have a considerable impact when dealing internationally, and thus should be looked into. Moreover, some countries are more politically unstable, so your mutual fund should always take into account such risks.

But let us first look at the bottom line of these mutual funds

Currency risk, tax treatment and India’s out performance vis-à-vis overseas markets have remained the key detriment to the growth of global funds. 2012 has not been a good year for overseas fund of funds because India was an out performer compared to other markets. The performance of funds investing in gold mining companies was tepid as these companies did not do too well. One of the primary reasons for the slow take off of these funds has been the love for Indian equities among investors and distributors. Indian markets gained 26% last year while the overseas fund category delivered 14%. Even over a three-year timeframe when global funds delivered around 6%, domestic funds focused on sectors like healthcare (17%), FMCG (30%) and financial services sector (14%) delivered comparatively better results. Based on returns of international funds by valueresearch.com, these funds have not performed better than diversified equity funds. While the average one-year return of diversified equity funds have been about 31% in January 2013 most international funds have had lower returns for the same period and certain funds clocked negative returns. Overall, a majority of the underlying funds (in case of international funds that are fund of funds) were rated poorly by international mutual fund rating agencies.

Pull vs. push

The low popularity of global funds can be attributed to the fact that these funds are looked at only as a diversification tool, which is largely marketed to sophisticated investors with a higher risk appetite. Advisors recommend keeping very low exposure to such funds. AMCs do not focus on mass retail investors. The assets of overseas funds have only declined since 2008. These funds were managing Rs 2947 crore in September 2008. Currently there are 32 global funds with assets under management of Rs 2295 crore, constituting a mere 0.3% of industry’s total assets. AMCs do not actively promote such funds on an ongoing basis due to lack of advisors’ and investors’ interest in these funds. It is more of a ‘pull’ product than ‘push’. Investors come if they are bullish about a certain market or theme’s performance in the near term and get out if they make some money. Retail investor’s averseness towards these funds is evident by the tepid response in NFOs. The recently launched ICICI Prudential US Equity Fund collected approximately Rs 56 crore. DSP BlackRock, which has a major share in this category (Rs 1009 crore as on November 2012), mopped up Rs 26 crore in its DSPBR US Flexible Equity Fund launch. Franklin Templeton’s FT India Feeder - Franklin U.S.Opportunities Fund got a better response collecting Rs 104 crore. Despite the not so enthusiastic response, many AMCs are planning to launch overseas funds to strengthen their product basket.

New funds in the pipeline

HSBC Mutual Fund plans to launch an HSBC Asia Pacific (Ex Japan) Dividend Yield Fund, which will invest in HSBC Global Investment Funds (HGIF) Asia Pacific Ex Japan Equity High Dividend Fund. Also in the pipeline is a HSBC Russia Fund. After partnering with Schroder, Axis is launching a fund called Axis Asian Income Fund, which will invest in Indian debt and in Schroder International Selection Fund Asian Opportunities Fund. Franklin Templeton is launching a fund called FT India Feeder – Asia-Lat Am Fund, which will invest in emerging markets in Asia and Latin America. Reliance AMC too plans to launch its Reliance US Equity Opportunities Fund. However, this fund will invest directly in US securities unlike a fund of fund, which invests in an existing master fund. AMCs with a foreign partner have usually taken the feeder fund route while others have invested directly in overseas stocks.

Will a global fund add value to your portfolio?

Mutual funds offer investors the opportunity to participate in the growth of some of the country's largest and most profitable companies. There is no dearth of choice here since hundreds of domestic equity funds promise exactly this. A handful of these deliver on this promise on a consistent basis. However, at times, even the best of the lot gets weighed down. However, not all funds are suffering. Many international funds seem to be doing well in an otherwise despondent market. For instance, Motilal Oswal MOSt Shares Nasdaq-100 ETF has delivered returns of 45% in the past one year. There are a few global funds being offered in the country, with Motilal Oswal joining the fray just over a year ago, while Franklin Templeton Investments launched a fund a few months ago. ICICI Prudential Mutual Fund is the latest asset management company to launch a product in this segment and more such funds are in the pipeline.

Does this imply that the investors who are disappointed with the local market should add a global fund to their portfolio? For most of us, investing beyond the border is an alien concept. We have a domestic bias in our investments, and for good reason. Being a growing economy with a powerful domestic consumption engine, we are spoilt in terms of expected returns from our investments. It makes sense to diversify through an international fund. Besides diversification, another benefit that these funds offer investors is access to unique investment opportunities that are not available in India. The best policy for investment is to have an international investing formula - 70% domestic investment and 30% international diversified funds investment.