FUND FLAVOUR

April 2015

Global/International Funds

For a global flavour…

If the persistent talk of policy paralysis, high inflation, rating downgrades, financial scams, and earnings slowdown is forcing you to defer putting money in Indian equities, it is time to consider investing abroad by buying units of global funds. These funds help you invest in equity but with less exposure to country-specific risks. Variously called global funds, overseas funds, and international funds, these are mainly fund of funds which invest in mutual funds with exposure to other countries. However, a few also invest directly in global equities.

While there are many ways to invest internationally, international mutual funds are a great way to gain exposure to international markets while simultaneously being diversified. It is also proven that investing in a mix of Indian and foreign stocks, has produced better returns, with less risk, than investing in the Indian market alone. It is no wonder then that there are so many different types of international mutual funds.

…on a platter

There are many different kinds of international mutual funds that you may choose to invest in to gain exposure to outside markets. You may choose to invest in one specific country; you may choose to invest in a mutual fund that specializes in multiple countries; you may purchase a mutual fund that specializes in sectors of the economy rather than purely demographic regions; or you may invest in multiple international mutual funds. The caveat is that each investment has very different risk and return profiles.

Global Funds

As the name suggests, these funds invest throughout the world, including the investor’s home country.

International Funds

These mutual funds are any funds outside an investor’s home country. For example, from an Indian’s perspective, it would be any funds not based in India.

Regional Funds

Regional funds are designed to focus on a specific geographic region. Rather than buy a mutual fund that invests all over the world, an investor could buy multiple regional funds.

Country Funds

These mutual funds focus on a single country, with the benefit being that the mutual fund would be specialized in that single country.

Global Sector Funds

Rather than focus on geography, global sector funds focus on a particular sector of the economy in various countries. This is great for gaining exposure to sectors rather than strictly countries.

The good, the bad, and the ugly…

Should you follow the herd overseas? The rewards could be substantial, but the same can also be said about the risks. Let us go over some of the things to keep in mind before going global with your portfolio.

The Good

The chief arguments in favor of mutual funds in general - instant diversification with a single investment, seasoned money management calling the shots, convenience, and reasonable liquidity - also apply to international stock funds.

Diversification
Diversification helps reduce the risk with any single investment. While there will always remain systematic or market risk with any investment, unsystematic, or specific risk, will decrease. It smooths out returns during periods of unpredictability.

Professional Management
Portfolio managers manage mutual funds. They rebalance the portfolio to match the investment objectives of the fund and decide what stocks to buy and sell for a modest fee. This is beneficial to those of you with little time or expertise to maintain your own portfolio.

Convenience
The mutual fund manages everything and you can sit back and enjoy a maintenance-free investment as long as they are invested.

Liquidity
International mutual funds can be bought or sold without worrying about a spread or how liquid the market is. They only take one day to settle when your net asset value is calculated at the end of the day.

Another major advantage is that you do not often have easy access to researching and buying overseas companies.

The Bad

Higher Expense Ratio

There is a price to pay for proven money management, and that comes in higher fees than typical mutual funds. Since most global funds in India invest in another fund, does that mean the investor has to pay twice? The answer is no. The fee that feeder/global funds charge is within the SEBI-allowed structures. This means the fund can charge up to the prescribed limit of 2.5%.

Currency Risk

Since many international funds do not actually hedge against currency risk, it is often a wild ride. Since global funds invest abroad, the investment is done in the currency of the country where the investment is made. There is a currency exposure that one takes while investing abroad. The returns may be impacted depending on how the rupee behaves vis-a-vis that currency. 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. This means any capital gain from these funds will be taxed at 10% without indexation and 20% with indexation. Short-term capital gains from debt funds are added to your income and taxed as per your tax slab.

Political Risk

Furthermore, there can be political risk, especially with emerging markets. The political stability of a country’s government can have a great impact on the value of the investment. Governments can change certain laws or there could be social unrest, which affects investments in those countries. Higher inflation can also decrease potential returns. Lastly, being overweight in one country, even outside of an investor’s domestic market, can be just as vulnerable as concentrating investments at home.

The Ugly

The pursuit for exotic returns also often comes with exotic risks. Investors learned that the hard way when the strong dollar ate into the returns of funds buying into overseas stock markets. The euro crisis and setbacks in Asia also stung results. The average large-cap international fund surrendered 4.8% of its value. That does not stack up very favorably to the S&P 500's better than 13% return.

There is also great volatility for international investors, particularly for those buying into country-specific funds.

So, there are some legitimate advantages to buying into international mutual funds. You get seasoned management that researches foreign equities for a living. That is valuable, but with few exceptions that exposure also carries greater risks. These funds may not suit a person who has a conservative approach to investment and is averse to investing in equity.

…and the impact on the fledgling global mutual fund market

Global funds are still evolving in India and have Rs 2,833 crore assets under management, or AUM, less than 1% of the mutual fund industry. In India, there are 41 global funds, which are commodity, country, and region-specific. Half of these schemes were launched during 2007-2010. Over the last three years, these have given an average annual return of 11%, with returns from individual funds varying from 0.5% to 20%. Global funds available in India have given mixed returns. Out of 41 funds which are diversified or theme-based, ING Global Real Estate and Fidelity International Opportunities Fund have been top performers with over 17% annual returns in the last three years. Both invest directly in shares of foreign countries. On the flip side, Birla Sun Life Global Precious Metals Fund has given a return of only 0.5%. The average return of international funds is -11.01% in the past year, among the worst across scheme categories. The value of Rs 100 invested a year ago stands today at Rs 88.99. Gold funds have returned -5.2%, while the Sensex is down 7% in the past year. The rupee is down nearly 10% against the dollar over the same period. Global funds also carry a higher expense ratio as most are feeders into their parent funds. Some of the worst performing international schemes are HSBC Mutual Fund’s Brazil Fund and Emerging Markets Fund, Birla Sun Life Mutual Fund’s Latin America Equity Fund and Global Commodities Fund, DSP BlackRock Mutual Fund's World Energy Fund and Mining Fund, and Mirae Asset Global Commodity Stocks Fund. Outcomes vary significantly across different international funds as they are not homogenous. In the last two years, the Indian market has outperformed its Asian peers resulting in funds focused on local equity outperforming their Asian equity counterparts. To fully appreciate the benefits of diversification, investors need to evaluate funds through longer cycles. The annualised return of international funds as a category from a three-year perspective was 1.07% and 1.74% over five years. Over the last three years, the annualised return of the Sensex was 13.05% while local equity schemes, across the board, provided annualised returns of between 14 and 32%. Only 13 schemes in the international category managed to provide positive returns to investors, though many did not make more than three per cent in the past year. Motilal Oswal Most Shares NASDAQ 100 ETF Fund, DSP BlackRock US Flexible Equity Fund, and Reliance Japan Equity Fund topped the charts with returns of 5.8-13.07%.

Are you investing enough abroad?

Your investments are like your vacations: you probably want to take some of them outside India. If you only invest in India, you ignore about half of the investment quality stocks in the world. It is like only looking at half the dinner menu. Investing abroad is also a smart move to diversify your investments. You do not want all your chips in one market. New investors should park about a third of their portfolio in foreign stocks, though the amount varies depending on your risk tolerance.

Here are a few keys to international investing:

1. Know your age, investing goals, and risk tolerance -- that will help you determine how much cash you are comfortable investing abroad. If you are in your 20s or 30s, investing abroad is a no brainer.

2. Invest with a long-term mindset: you should not buy today and sell tomorrow. Think decades.

3. Look for high growth areas. 

4. Focus on value. One key measure of value is the price-to-earnings (P/E) ratio.

No doubt, there are daunting headlines across the globe. Greece could default this year, China's stock market could be in a bubble, and Brazil is a mess. But if you are buying now and holding on for the long haul, foreign stocks are cheaper and generally have more room to grow than Indian stocks. One of the best ways to understand value and compare one market to the next is the P/E ratio. You can find companies with these characteristics with cheaper valuations – that is one reason why it is important to expand your horizons and invest internationally.