FUND FLAVOUR

May 2021

International/Global Funds

With the awareness levels of Indians about investment options around the world increasing by leaps and bounds, the need for portfolio diversification is greater than ever. A diverse plan not only mitigates risks by spreading the risks across a mix of assets and markets but also taps the earning potential of different markets. Global investments offer the opportunity to invest in larger or fast-growing economies and even specific stocks or sectoral opportunities that are not present in India and helps boost the quality of the portfolio. Indian markets have lower correlation with international markets. According to a report by Mirae Asset Mutual Fund, Indian markets have a low correlation of 0.16% with the US, 0.32% with Europe and 0.38% with China. So by investing in international mutual funds that invest in the above-mentioned markets, the overall portfolio risk will be less. International funds give investors several opportunities in new age industries like ecommerce, social media, electric vehicles, cyber security and cloud computing among others. Amazon, Netflix, Facebook, Twitter, Louis Vuitton, Walmart and Tesla have been outperformers over the last few years. So by investing in International funds, exposure to these stocks is made possible. Many global companies have strong moats and competitive advantages that many Indian companies lack. Investing in them gives an automatic hedge against the rupee. Further, they help diversify portfolio risk at the country and currency level. Expanding the portfolio to global investments also ensures better risk-adjusted returns and international exposure under expert management.

 

However, despite its many advantages, a majority of Indian investors shy away from investing globally. Global investing is not as complicated as it seems and can help you achieve a well-diversified portfolio. But all these advantages come with a fair amount of risks - risk of volatility in currency exchange rates, difficulty in accessing information on how the companies linked with those funds are performing, any regulatory or change in business plan happening, etc., and economic and political changes of those countries. Moreover, international funds are taxed as debt funds unless 65% of their assets are held in Indian equities. Short-term Capital Gains (for a holding period of 36 months or less) will be taxed as per the tax slab (as per the marginal rate of taxation), while Long-term Capital Gains (for a holding period of 36 months or more) will be taxed at 20% with indexation benefit.

 

The modus operandi…

There are four ways in which Indians can invest in global markets: Direct Investments, ETFs, Global Mutual Funds, and Fund of Funds. Investors need to open a separate trading and demat account with an international company or maintain an international broking account with an Indian company for direct investments and ETFs. Investing internationally via mutual funds and FoF seems like the most convenient routes to access global opportunities. While global mutual funds and international funds are often used interchangeably, there is a slight difference between the two. International funds invest in countries other than the domestic market, while global mutual funds invest in all the countries across the globe (including the domestic market). These funds offer the advantage of being able to access global companies through domestic fund houses and also the expertise of leading fund managers across the globe. In the case of an international FoF, investments are made in a mutual fund managed by an international fund house that invests in shares and bonds of global companies. The fund manager selects a FoF which aligns with the risk profile and investment philosophy of the scheme. One can invest in these funds without the need to open a separate overseas trading account. Small investors can also access these funds. Allocating a small percentage of the portfolio to global mutual funds can be a wise strategy to reduce volatility, manage risk and diversify the portfolio in the true sense.

 

Overseas investment limits enhanced…

The capital market regulator, SEBI through a circular dated November 5, 2020, enhanced the overseas investment limits applicable to mutual funds from US$ 300 million to US$ 600 million per mutual fund without making any change to the industry-level limit of US$ 7 billion. Currently, the Indian mutual fund has collectively exhausted just about 13% of the industry-level limit of US$ 7 billion despite the growing popularity of overseas funds. SEBI has also increased the ceiling on mutual fund investments in overseas Exchange Traded Funds (ETFs) to US$ 200 million from US$ 50 million earlier but kept the industry limit unchanged in this regard at US$ 1 billion. For ongoing schemes that invest or are allowed to invest in overseas securities/overseas ETFs, an enhanced investment headroom of 20% of the average AUM in overseas securities/overseas ETFs of the previous three-calendar-month exposure to overseas securities/overseas ETFs for that month is permitted by regulator subject to the maximum specified limits. Mutual funds investing in the overseas markets will have to mention the amount they intend to invest overseas in their scheme documents. Moreover, the utilization of overseas investment limits is required to be reported in the monthly statement within 10 days from the end of each month. If such limits remain unutilized for six months, it will be available for other fund houses to utilise.

 

Zeroing in on the right funds…

Assets in international schemes available through domestic mutual funds have seen a sharp rise over the last one year. The number of folios rose 250% to 7,00,000 in March 2021 as against 2,00,000 in April 2020. During the same period, the assets under management rose 278% to Rs 12,408 crore from Rs 3,282 crore. With 46 international funds to choose from, over the past one year, the top three funds have delivered 97 percent returns. DSP World Mining Fund, a scheme that invests in equity shares of gold-mining companies, gave 95 percent return over the past one year. It is among the five best international funds over this period. But the bottom three funds have given just 26 percent on an average. Of the 14 international funds that have a 10-year performance record, only four have delivered annualized returns greater than 10 percent. HSBC Brazil Fund was launched with great expectation nearly 10 years ago. Its performance languished for a good part of that period. As of August 2020, it was down 23 percent. A fund investing in Greater China Equities or US tech stocks could have delivered returns in excess of 20 percent annually, five or six years ago. But countries go through their own cycles of boom and bust and that may not coincide with how the Indian economy or markets perform.

 

Just as with investments in Indian equity funds, for overseas schemes, too, it is important that you buy and hold for at least 5-10 years. Choose well-diversified portfolios and investment themes when it comes to international funds. For example, globally diversified schemes or those investing in broad-based US equities or European stocks can be considered. Such portfolios will have a large and liquid basket of listed securities for portfolio construction. Schemes that invest elsewhere in Asian or emerging markets should come next. The last in line are thematic and sector based international funds. These are the riskiest and are cyclical in nature. Before zeroing in on the fund…Check the pedigree of the scheme and the fund house. Analyse the consistency in delivering returns. Typically, avoid new fund offers unless they offer a geography or theme that is new. International funds also act as a long-term hedge against rupee depreciation. However, overseas funds are not for first-time equity or mutual fund investors. Only after having accumulated experience in market-linked investing, look for diversification through these schemes. Whatever the reason for picking an international equity fund, it is not a ‘one size fits all product.’

 

 

The bottomline…

Never make the mistake of including International Funds as a part of the core mutual fund portfolio. Make sure there is a good portfolio in India, which can help absorb the shock of any sudden changes in foreign markets, before investing overseas. Investments should be spread across different asset classes like PF, PPF, FD, real estate, gold, mutual funds, stocks, etc. Without a good asset allocation in India, foreign investments should not be considered. 10-20% of portfolios in international equities serves as a hedge against the vagaries of the domestic market.