FUND FLAVOUR

April 2020

International/Global Funds

With international stock markets comprising about 45.5 percent of the world’s capitalization, a broad range of investment opportunities exist outside the borders of India. For investors who are looking to diversify their mutual fund portfolio with exposure to companies located outside India, there exist two basic choices: International and Global Mutual Funds. International Mutual Funds are funds that invest in foreign markets except for the investor’s country of residence. On the other hand, global funds invest in foreign markets as well as the investor’s country of residence. International Mutual Funds are also known as “foreign funds” and are a form of the ‘fund of funds’ strategy. International Mutual Funds have become an attractive investment option for investors in the past few years due to the volatile local markets and an economy going through its ups and downs. With the permission of Reserve Bank of India (RBI), International Mutual Funds opened up in India in 2007. Each fund is allowed to get a corpus of USD 500 million. International Mutual Funds follow a master-feeder structure. A master-feeder structure is a three-tier structure where investors place their money in the feeder fund which then invests in the master fund. The master fund then invests the money in the market. A feeder fund is based on-shore i.e. in India, whereas, the master fund is based off-shore (in a foreign geography like Luxembourg etc). A master fund can have multiple feeder funds.

The Structure…

Global funds can be structured according to the following ways:

a. Depending on the mode of investment

i. Funds that invest directly

These are funds which are directly handled by the local fund manager. Instead of relying on a fund manager who lives offshore, your local fund manager makes sure to look after your portfolio.

ii. Funds that invest indirectly

These funds are known either as feeder funds— because they pool in money from local investors and then transfer the corpus to the parent fund which is managed offshore— or pure fund of funds—these are funds that invest the investor’s money in a basket of offshore funds.

iii. Funds that invest only a portion in foreign equity

These funds have a mix of both domestic and global funds. Hence, they are better choices for the moderate risk taker as they provide limited exposure to foreign equities while maintaining focus on the domestic market and thus enhance your portfolio’s tax efficiency.

b. Depending on the region of investment

i. Region-specific funds

When opting for global funds, you can choose to invest only in a specific region or country. This works well if the region/country of your choice has the potential for high growth, but to achieve this you would need a deep understanding of the region to capture the growth and exit at the right time. 

ii. Funds that invest across the globe

These funds are more flexible as they are not restricted to a particular region and can offer more diversified exposure to investors. They are generally handled by fund managers who have the necessary expertise in handling an investor’s portfolio and can identify and monitor opportunities worldwide.

c. Depending on theme

These funds invest in specific themes or growth opportunities across the globe. You can choose to invest in broad themes or sectors like commodities, energy, gold, agriculture, mining, and others. These funds are great to invest in when there is a growth period, and you can have access to segments which may not be available for investment in the domestic market.

…Features ...

Some of the distinguishing features of Global Mutual Fund are highlighted below:

a. Diversification 

The main objective of investing in a Global Mutual Fund is to diversify one’s investment portfolio. These funds invest in multiple securities in different countries, thus creating a wide array of investment instruments at one’s disposal.

b. Risk factor

When you invest in international markets, the risk depends on country-specific policies and market conditions. Investing in stable markets reduces the risk factor.

c. Currency factor

Fluctuations in the value of an international currency can have a huge impact on the performance of a Global Mutual Fund, but since these are not very frequent occurrences, the risk is not that high.

d. Hedge 

A global fund functions as a hedge against inflation.

e. Returns

Returns offered by a Global Mutual Fund could vary, owing to multiple parameters like currency exchange, global politics etc.

f. Term

Most global funds are long-term funds.

g. Dual Market RiskThe other country’s current market fluctuation and the sectoral market (real estate, IT, etc.) can impact the performance of the fund. Hence, it needs a lot of research to make the right choice.h. Tax-Efficiency

There is also the issue of taxation that could prove to be a potential pitfall. For instance, hybrid global funds invest 65%-70% of their corpus in domestic companies and the remaining in overseas markets. International funds are taxed as debt funds, unless they invest at least 65% of their portfolios in Indian equity instruments. When treated as debt funds, short-term capital gains are taxed at the investor’s marginal rate of tax and long-term capital gains on investments held for more than 36 months is taxed at 20% with indexation benefits.

…diverse hues

1. Emerging Market Funds

This type of mutual fund invests in emerging markets like India, China, Russia, Brazil etc. China has surpassed the USA to be the world’s largest car manufacturer. Russia is a big player in natural gas. India has a fast-growing service economy base. These countries are expected to grow tremendously in the coming years making them a hot choice for investors. Some of the best international mutual fund schemes that invest in emerging markets are Birla Sun Life International Equity Plan A, Kotak Global Emerging Market Fund and Principal Global Opportunities Fund.

2. Developed Market Funds

Developed market funds are an attractive option because it is generally seen that mature markets are more stable. Also, they do not have the problems associated with emerging markets like an economy or currency risk in the economy, political instability, etc. making them less risky. Some schemes that invest in developed markets are DWS Global Thematic Offshore Fund etc.

3. Country Specific Funds

As the name suggests, this type invests only in a specific country or part of the globe. But, country-specific funds defeat the entire purpose of diversifying the portfolio since it lays all eggs in one basket. However, when there are opportunities in specific countries due to various reasons, these funds become a good choice. Reliance Japan Equity Fund, Kotak US Equities Fund and Mirae Asset China Advantage Fund are some country-specific schemes.

4. Commodity Based Funds

These funds invest in commodities like gold, precious metals, crude oil, wheat, etc. Commodities offer diversification and also act as an Inflation hedge, thus protecting the investors. Also, these funds could be multi-commodity or focused on a single commodity. Best commodity based international mutual funds are DSP Black Rock World Gold Fund, ING OptiMix Global Commodities, Mirae Asset Global Commodity Stocks, Birla Sun Life Commodity Equities - Global Agri Fund, etc.

5. Theme Based Funds

Theme based funds or thematic funds invest in a particular theme. For example, if the theme is infrastructure, it would invest in infrastructure construction companies as well as companies related to the infrastructure business like cement, steel, etc. They are often confused with sectoral funds which focus only on a specific industry. For example, pharmaceutical sectoral funds would only invest in pharma companies. Compared to sector funds, thematic funds are a broader concept. This offers more diversification and less risk since the investment is spread across various industries. Some theme based funds are DSPBR World Energy Fund, L&T Global Real Assets Fund etc.

In the limelight…

International funds have been in the limelight lately due to their impressive performance over the last few years. These schemes have a strong case since 90% of the investment opportunities in the world are outside India. Geographical diversification will have a positive co-relation to the Indian market unlike asset class diversification. Most investors go for US-based funds when they diversify into international funds and the US market has fallen around 12 per cent since November last year. This is a similar condition that the Indian market has seen in the last one year. The similarity in returns is attributed to the fact that Indian markets suffered partly because of the international pressures like US-China trade war. Such phases where the Indian and international markets go through similar streaks are inevitable. Countries, their economies and their now liberalized stock markets are highly interconnected due to international financial flows moving in and out swiftly, and freely. For example, when Lehman Brothers collapsed in the US in 2008, Indian markets witnessed a major pullback of FII flows as investors moved to safe havens. A close look at the category shows that the top three funds in the category have given over 20 per cent returns in the last one year. However, these schemes are mostly global gold funds. In the last one year, HSBC Brazil Fund has given 21.56 per cent returns when Indian equity schemes have been going through a rough phase. International funds are topping the charts in the last one year. In fact, they have given over 20% returns in 2019. The international mutual fund category has offered 18.85% returns in one year, 10.02% returns in three years, and 7.45% returns in 5 years. However, these schemes have gone through many ups and downs in different calendar years. For example, International funds went through a bad phase in 2018 and 2015, when they posed -5.54% and -6.15% respectively. If you were to sort all equity mutual funds available for retail investment by their one-year performance, international funds would come on top. The best performing funds in this category gave one-year returns of over 20%. In comparison, exchange-traded funds and index funds that tracked the Sensex gave returns of less than 15% in the same period, while actively-managed equity funds fared badly with the top five large-cap funds giving an average return of around 9% and multi-cap funds faring marginally better at 10%. Should international funds then make it to your portfolio?

The pros and…

Global Funds can be a great asset to your investment portfolio.

1.   Diversification: Investing in international funds, help investors to diversify their portfolio and give them access to the broad markets. Hence, when there is a market low in the home country, investor’s international funds would help them compensate for it.

2.   Balance economic volatility: Investing in mutual funds of various economies, help investors to earn a good return, and get the benefit of different economic cycles. Also, this very process helps to nullify the losses of economic volatility of the investments by profiting from better performing economies.

3.  Access to foreign blue-chip companies: Some of the giant companies like Google, Microsoft or Cola, do not have their shares listed in Indian stocks, thus the only way of investing in their shares is through international mutual funds or direct investment.

4.   International Exposure under Expert Management: If you are worried that, you are not aware of the facts related to international funds and you do not know the condition of the foreign market and are backing out from international funds, a qualified intermediary can assist you with your investment. Therefore, you can gain exposure to the global market, even if you are not familiar with it.

5.  Easy Liquidity: Liquidity is one of the most important aspects of any investment. A liquid asset is a term used for assets whose shares can be exchanged for cash in a very short time period, ideally, within a business day or two. Once you have sold your share, you will receive the amount equal to your investment’s value at the time of the market closing. However, since the value of a fund is directly dependent on the prevailing market conditions and performance, the value which the investor will receive upon redemption may be above or below the original cost of the share.

6.  Convenience: Another important advantage of mutual funds is the convenience which they offer in terms of the administrative aspects of ownership of assets. All information related to your investment like account statements, tax status of capital gains, dividends received from the fund will all be sent to you via email for easy tracking and monitoring.

7.  Can contribute to a cost-effective portfolio: You can utilise this exposure to foreign money to meet major financial goals (like your child’s wedding or college education). When it comes to overall value, Indian equities as well are not cheap. So, a wisely-picked International Fund can balance this out.

…the cons

As with any investment, international investing carries risks, including some unique to international markets, such as currency risk or changes to economic, political, or regulatory conditions. These risks can be magnified in emerging or developing countries due to their less regulated markets and economies. In some cases, these factors can cause greater volatility of stock prices and fund performance. Investing in mutual funds, rather than individual stocks, can be a way of mitigating some of the risks described below.

Economic risk: This refers to the stability of a country’s economic climate. A country with stable finances and a relatively strong economy is likely to provide a more reliable investing environment than a country with weaker finances or an unsound economy.

Political risk: This risk refers to a country’s political climate and how that climate may result in unanticipated losses to investors. Political risk is sometimes referred to as the ability of a country to maintain a hospitable climate for outside investment. Even if a country's economy is strong, an unfriendly political climate (or one that becomes unfriendly) to outside investors could present a greater risk to investors.

Currency/exchange rate fluctuations: The exchange rate between a country's currency and the US dollar fluctuates constantly. This can impact the dollar value of an investment, even if the security's price remains unchanged. In some cases, though, currency fluctuation can work in your favor. For example, returns on foreign stocks are increased when the dollar's value falls relative to other currencies.

Less information: In many cases, foreign markets and the stocks issued by foreign companies are not as widely followed by financial analysts. As a result, investors may have to make decisions based on information that may not be as complete as when they are investing in US securities. However, this can also present an opportunity for active managers to use research capabilities to potentially identify and take advantage of less-known securities.

Reduced liquidity: In some foreign markets, securities trade with much less frequency. This reduced liquidity could make it more difficult to buy or sell certain securities, which could either reduce the profits you have made or increase your losses if you are forced to sell shares.

Criteria for contemplation…

When you are investing in an international fund, make sure to invest in a market that is developed. The markets that have 70-80 years of functioning should be preferred. International funds offer a good quality of portfolio diversification to its investors along with a good opportunity for earning a good return from the growth of companies around the world, but at the same time these funds have their own set of risks and benefits. Political, social and economic aspects in different countries can impact mutual fund performances differently. Hence, the investor needs to keep track of the market movement regularly, with good concentration. If you are convinced about the efficacy of international funds, you may consider allocating a small part of your portfolio to them, only if you have a sizeable portfolio. International mutual fund category is underlining their importance as a diversification tool in investor portfolios. Do not expect high returns from diversifiers. They just need to protect the downside. If you are a mature and well-informed investor with a good understanding of domestic and global markets, then go for a 10% to 15% allocation to foreign funds. So, it is best to use overseas funds to supplement your main domestic fund portfolio. However, they are not for passive investors as they need careful and continual market study. Investors should be sure of their investment goals, both short-term and long-term, before investing. Check track record– they will help you choose a fund that suits your requirements.