FUND FLAVOUR

April 2015

Global/International Funds

In a world that has become increasingly connected, inviting the world into our investment strategy seems like a no-brainer. Indian investors largely ignore this global interaction and the opportunity to tap those investments. To change that disposition, embracing the whole world on a global basis may be something you should consider. “International” and “Global” have different meanings when it comes to investments. International refers to anything outside the Indian borders. Global includes India in a whole world strategy. On offer are three types of funds: those that allow direct investing into global markets; funds that use the feeder route to invest in an existing global fund; and lastly, fund of funds that invest in several funds to achieve international exposure. Moreover, variety in international funds also comes from the fact that some of them invest in a particular region (say, China or South America). There are others that are commodity plays. They could be investing in gold mining companies or in agri-based companies, and so on. You even have passive funds in this category. So, this is obviously a category for the sophisticated investor who knows exactly what kind of exposure he wants.

On a positive note…

Like foreign travel or cuisine, international investing can be a great way to diversify your portfolio and discover new opportunities that you otherwise might have missed by sticking close to home. International mutual funds offer two big advantages for small investors: access to professional management and instant diversification. When you invest in an international stock fund, you are buying a slice of larger, more diverse portfolio than you could ever hope to assemble on your own. The reason you should consider global investments is that by spreading your money among several markets, you achieve what stock market theorists have been propounding for years -diversification and hedging risk by spreading it across a mix of assets and markets. Individual economies are subject to economic cycles. By investing in several economies at a time, your portfolio can earn smoother returns. Besides reducing risk through diversification, global investing can also boost your portfolio returns. With no country managing to be at the top of the charts each year, the case for spreading your investments across countries definitely gets stronger. What is more, all the investment decisions are made by portfolio managers with experience in global markets. Liquidity and convenience are the hallmarks of any mutual fund investing, not to mention, international funds.  It has been observed over the years that a judicious combination of foreign and domestic investments generate better returns at lower levels of risk.

On the flipside…

While investments in all mutual funds involve risk, investing in foreign securities presents certain unique risks not associated with domestic investments, such as currency fluctuations and changes in political, regulatory or economic conditions. There is the risk of volatility in currency exchange rates. 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. There is also the issue of taxation that could prove to be a potential minefield. Since hybrid global funds invest 65-70% of their corpus in domestic companies and the balance in overseas markets, investors in these funds are eligible for the tax exemption on long-term gains from these funds. The capital gains from other funds that invest in overseas markets are treated in the same way as long-term capital gains from debt funds. All these factors may result in greater share-price volatility. These risks are magnified in emerging or developing markets due to their less established markets and economies. International equity mutual funds may not be appropriate for very conservative investors, but for those seeking to broadly diversify their portfolios to include the global investment universe, and willing to bear a higher degree of risk, they can literally offer a world of opportunities.

Lacklustre performance?

Gold, commodities, real-estate and sectors where there are limited opportunities to invest in India — these are some themes that international funds sport. In the past, a depreciating rupee against the dollar helped these funds deliver well. But a stable or improving domestic currency over the past one year has meant reduced returns. International or global funds have continued to underperform their domestic diversified peers across timeframes. Among the 31 global funds, only 15 funds have a five-year track record. Birla Sun Life Global Real Estate, formerly known as ING Global Real Estate, has topped the table by delivering an annual return of 14% over the past five years. Over a one-year period, the funds have gained only 10%.

Bottom of Form

International funds have failed to match the outstanding performance of their domestic counterparts in 2014. The category trailed all other categories of mutual funds except for gold funds by a wide margin and managed to offer only 2.56% average returns to investors in the past year. During the same period, diversified equity funds offered an average return of over 30% and mid- and small- cap funds gave an average return of 74%. Ten mid- and small-cap funds posted returns above 85%, with micro-cap funds leading the pack. Even debt funds with a longer-term maturity like gilt and income funds have generated an average return of 16% and 13% on hopes of a rate cut amid moderating inflationary pressures. Most domestic equity mutual fund schemes have posted a phenomenal performance in 2014 as the market touched an all-time high. There was a turnaround in the economy after the general elections. Macroeconomic variables turned favourable with oil prices falling, reduced inflation rates, markets breaking new records every day and overall improved sentiment in the economy. Amidst all this euphoria, international funds cut a sorry figure. Among them, thematic funds were the worst hit, with some funds posting negative returns during the previous year. For example, DSP Blackrock Mining Fund offered the lowest return of -22.38% and HSBC Brazil around -19.73% last year. Funds with gold, commodities, and energy as underlying themes in the international fund category have also fared poorly. These funds did not deliver even in 2013.

Winning themes…

An analysis of the returns of global funds over the last one and three years shows that two themes worked well. One, funds which invest in Asia. In the last three years and especially over the past one year, many funds which invest in Asian markets — China, Singapore, Indonesia, Taiwan, and South Korea — have done extremely well, delivering 15-22%. These markets offer attractive avenues for investment in sectors such as semiconductors, energy, utilities, mining and telecommunication services. Some markets such as Mexico and Argentina too have rallied quite well, though Brazil continues to be a laggard in the Latin American market. In this category, funds such as Templeton India Equity Income, JP Morgan JF Greater China Equity Offshore, JP Morgan JF ASEAN Equity Offshore, and Kotak Global Emerging Market delivered a 12-29% over the past one year. Funds which invest in developed markets, on the other hand, saw very few outperformers. But Birla Sun Life International Equity – Plan A has been a consistent performer in this category as it invests in the US, Germany and a few other European countries, making it a well-diversified basket. Markets in these countries are trading at multi-year highs. The second winning theme was real estate, but only one fund capitalised on this. ING Global Real Estate has delivered exceptional returns of 15.3% over the past three years and 21% in the last one year. The scheme invests in stocks and REITs from across the world.

Losing themes…

While international funds playing on Asia and real estate did well, those betting on commodities and natural resource-reliant countries fared poorly. The weak global economic outlook led to a very sedate performance from a range of commodities in the past year. Coffee and sugar prices, for instance, have fallen substantially on higher trade surpluses. With key consuming nations such as Europe seeing poor demand, crude oil and base metal prices too have been flat. Funds which bet on commodities and agricultural products or specific countries expecting them to benefit from a rally have seen erosion in NAVs. Mirae Asset Global Commodity Stock, ING Global Commodities, Birla Sun Life – CEF – Agri Plan, have all delivered poor returns for this reason with declines of 4-5% in the last one year. In a surprising twist, funds that bet on gold mining stocks have proved laggards too. Gold prices have fallen, with its safe haven allure fading with rebounding equity markets. On top of this, stocks of gold mining companies have trailed the yellow metal. Companies such as Newcrest, Goldcorp, and Kinross have witnessed around 30% fall in their stock prices in one year. This has decimated NAVs of DSPBR World Gold Fund and PineBridge World Gold Fund, which invest in this space, with a 18-19% erosion in their NAVs. Among funds riding on such themes, L&T Global Real Assets (earlier Fidelity Global Real Assets) has been a consistent performer. It has delivered over 12% annually over the past three years, outperforming both domestic funds and most international schemes.

Points to ponder

Given this mixed performance, should you invest in global funds? There are many positives to it. First, you diversify risks by investing across markets. The international basket is much wider than the domestic. Second, global markets are cheaper. For instance, the DJIA, S&P 500, FTSE, and CAC trade at 13-14 times historic earnings (Bloomberg), while domestic benchmarks are at around 16 times. Two, despite the rally in the developed markets, the valuation multiples are also at par or lower than their historic averages. Third, the icing on the cake — gain from a falling rupee.

The bottom line for investors

Do, however, take the following points into account before the plunge. One, international funds are treated as debt funds and taxed accordingly. Two, while global funds may appear good for diversification, Indian markets are likely to offer better returns over the long term. Hence they must form not more than 20% of your portfolio depending on your risk tolerance and focus on growth. Three, avoid high-risk commodity or theme-based funds; they require timing. Finally, invest in funds with long-term track record and mandate.

Take the SIP route to build a global portfolio

If you want a truly diversified portfolio, having an investment in international equities is essential. While there are some risks, and some investors fear the unknown, international equities make up a large part of the world market's potential investment growth. Begin with a 5% exposure to international equity and gradually raise it to about 20% of your equity portfolio. The SIP route is important because these funds are subject to dual volatility—equity market and currency oscillation. Hence, it is all the more important to use rupee cost averaging to smoothen out this volatility. Of the 20% exposure, invest a portion of it in the developed markets and the balance in the emerging markets. Conservative investors will favour developed markets over emerging markets. Your foray into international markets should begin with passive schemes, such as index funds and ETFs. These are low-cost funds and offer market equivalent returns. Only when you are ready to take higher risk and know the market better should you venture into actively managed funds. Look for the word "international" as opposed to "global" when choosing a foreign investment fund.