FUND FLAVOUR

April 2014

 

Spread your wings!!

 

Financial markets across the globe are getting increasingly interlinked and the systematic risks of the global markets have increased. On the contrary, there continues to be a stark variation in the returns posted by the different markets over the long as well as the short run. Therefore, despite the increasing financial integration, different economies continue to move through different phases of economic cycles. Going by this logic, global exposure can make your investments truly diversified. One of the simpler ways through which you can do this is through mutual fund investing across different geographies. There is a vast choice available for an investor to offset risk due to domestic markets by taking exposure to international markets through mutual funds.

 

Why Global Funds?

Global Funds provide a unique opportunity to domestic investors to participate in international markets. Because the world is a single market, a global fund allows you to benefit from major international developments. Moreover, investing in specific markets can help you leverage your inherent strengths, for example, Latin America (commodities), Asia region (services), US (has a highly diversified economy and is a key market for emerging regions), BRIC (highly promising developing economies) all have specific industries that outperform others.

·       Global Funds are considered as an excellent opportunity for diversification in the true sense because investing in global funds provides access to a wider range of markets reducing exposure to country-specific risks. Since global markets usually do not move in the same direction, spreading your investment across geographies can serve as a hedge and protect your portfolio from risks of volatility in the market. 

·       Since there is no particular market index which has managed to deliver consistently high returns over years, the idea of spreading your investments across countries definitely gets stronger and boosts your returns. 

·       In times when the domestic markets are dull and down, venturing into global markets provides a wider opportunity to investors. 

·       Investing in international funds gives you a chance to invest in areas/markets that are normally inaccessible. 

·       Although global fund opportunities are invariably evolving, there is a wide range of investment themes that these funds offer. These can be based on geography, asset-classes, commodities, and sectors to name a few. However, just like any investment option, global funds also bring certain risk factors along with them.

 

A note of caution!

 

·       Investing in international funds is not for first time investors in stock markets. It is for more seasoned investors looking to diversify away risks. It is not wise to just look at glittering returns and make an investment. Investing in international funds is tricky and you should make a cautious start by investing in a sector or theme that you understand and can track. Only then can you increase your exposure to global markets through global mutual funds. 

·       Foreign exchange risk is the main reason to be wary about when investing in global funds as it can work for an investor both ways. If the foreign currency in which your fund is invested falls in value vis-a-vis the rupee, then your investment returns will suffer despite the gains your fund may have made in the market. Thus, if at redemption, the rupee has depreciated against the dollar, you will earn more, and if the rupee has appreciated, your returns will be hit. 

·       Geopolitical risk, in the form of unfavourable conditions in the country where investment is made, such as earthquakes or riots, can influence the return on investment. Investors are advised to invest in a wider geographical scenario, so that they can freely exit affected regions without losses. 

·       Most global funds are in the form of a fund-of-fund structure where the Indian fund invests in either one feeder fund set up abroad (which invests according to its mandate) or in a basket of underlying international funds. These kinds of funds suffer from the fact that there is a limited access for the investor to gather adequate information about the underlying global fund(s) to determine its suitability. 

·       There are higher costs involved due to the fund-of-fund structure that exists in general. Global funds may have a higher expense ratio due to the dual nature of management expenses involved at the local and international levels. 

·       You should note that when investing in global funds, a large chunk of the principal is placed in foreign equities. These are treated as debt funds and taxed accordingly. Long-term investment returns are levied at 10% without indexation and 20% with indexation. Short-term gains are included to the income and taxed according to the applicable slab rates.

 

Flavour not yet savoured

 

There are not too many global funds in the nine years since the government allowed Indian mutual funds to invest abroad. No more than Rs 2,400 crore of assets is there in thirty-two such funds. For much of the period for which easy international investing through mutual funds has been possible, Indian investors have not paid much attention to it because the Indian stock markets were doing much better than others. Since investors start with a bias for the familiar, they have not paid any attention to the fact that slowly but surely a combination of equities performance and the decline of the rupee have made the logic of such diversification stronger and stronger. Through these years, while big businesses and the superrich have responded robustly to the easing of capital outflow, the opportunity has mostly been ignored by the smaller investor. Part of the blame also lies with the kind of international funds that the Indian fund industry has launched. A large proportion (22 out of 32), of the actual international funds launched are specialty funds, or gimmick funds, to give them a more appropriate name. Instead of diversified funds (whether actively managed or indexed) based on the major markets of the world, we have global real estate or agri-business or mining funds or Latin American or China funds and so on and so forth. These are just marketing gimmicks that have shifted the onus of deciding whether Latin American real estate will do better or Chinese agri-business will do better to the investor.

 

With Rs 2068 crore assets under management, international fund of funds are yet to gain wider acceptance among advisors. There are two reasons for the slow take-off of these funds. Firstly, advisors believe that Indian markets can offer much better returns compared to overseas markets. Secondly, advisors believe that it is better to invest in markets which you are familiar with and fully understand. It is advisable to invest in funds which offer broad and familiar investment themes like gold, US equities, etc., compared to those with niche themes. Another factor investors should consider when investing in such funds is the expertise of the AMC in managing the theme. Typically, foreign AMCs with their global presence and availability of a track record for the parent fund (in which the domestic feeder fund would invest in) are usually the preferred choice for investors.

 

Exemplary Performance

 

Depreciation of rupee has put international funds in the limelight with the category posting 19% absolute return in one year. With the rupee continuing fall against the dollar, investors in international funds are making a killing. The Indian rupee has depreciated 22% against the US dollar since January 2013. International fund of funds which invest in overseas funds have delivered an average of 19% absolute return in one year, according to data from Value Research. It is not just the falling rupee which has helped these funds. The US market has done well as compared to the domestic markets. The S&P 500 index is up 16% YTD while the BSE S&P Sensex is down 5% during the same period. Domestic diversified equity funds, on the other hand, are not doing well. Among sectoral funds, banking and infrastructure funds have lost the most at -13% and -17% respectively. Technology funds, which invest in IT companies which derive a major portion of revenues from overseas markets, have delivered 31% absolute return in one year.

 

Take Away!

 

Investors looking to diversify within equity can invest in international funds and mitigate the country specific risks to an extent. These funds may not suit a person who has a conservative approach to investment and is averse to investing in equity. You should carefully assess the risks before taking an exposure to international markets through mutual funds. A close watch should be kept on the currency movement. Global investments in your portfolio may act as a return enhancer and hedge as well. Primarily, foreign funds are ideal for investors who intend to diversify their equity portfolio. Investment in foreign mutual funds should be such that it holds very less or negative correlation with the domestic market. Only under such circumstances can investors reap optimal returns from investment in foreign mutual funds.