Decoding emerging market funds and options available to investors in India

Opportunity to diversify in different countries, themes, sectors and companies, these funds also help to hedge against rupee depreciation as investment are made in the emerging market which have...

Decoding emerging market funds and options available to investors in India

One of the biggest advantages of investing in the mutual funds is diversification. Mutual funds facilitate diversification not just across asset classes but also across countries which helps to mitigate risk and attain optimum returns. Emerging market funds is one such mutual fund variant investing majority of its assets in emerging markets which are expected to grow rapidly and likely to be future growth engines of the world. Besides opportunity to diversify in different countries, themes, sectors and companies, these funds also help to hedge against rupee depreciation as investment are made in the emerging market which have different currency and hence it can help to limit the losses when the rupee is falling. These funds are typically funds of funds which invest in the units of overseas mutual fund. They may also invest small portion in debt and money market instrument.

While there are several emerging markets across the world, the four largest ones are popularly known as “BRICS” – Brazil, Russia, India, China and South Africa. The Morgan Stanley Capital International (MSCI) has a MSCI Emerging Markets Index capturing large and midcap representation across 24 Emerging Markets (EMs) countries including China, Taiwan, India, South Korea, Brazil and other nations. The chart below shows the annual performance of the MSCI Emerging Markets Index. While the performance of the index has been discouraging in the year 2021 down 2.54% owing to worries about rising interest rates and pandemic induced slowdown; the index returned 18.31% and 18.42%, respectively in the year 2019 and 2020, respectively.

Going forward higher inflation, gradual increase in the interest rates and the Russia-Ukraine war are some of the key factors that are likely to weigh on the performance of the emerging markets. But investors with a higher risk appetite can look it as an opportunity to invest a smaller portion of their portfolio in the emerging market funds for the long-term horizon.  

Some of the funds available to investors in India are: Edelweiss Emerging Markets Opportunities Equity Offshore Fund, HSBC Global Emerging Markets Fund, Kotak Global Emerging Market, Aditya Birla Sun Life Global Emerging Opportunities Fund and PGIM India Emerging Markets Equity Fund. Evaluation of the portfolio attributes, performance across time period vis-à-vis peers and benchmark, expenses involved, taxation along with the risk factors is crucial before investing.

Note emerging market funds offer higher growth potential but subjected to several types of risk. Like for instance, country specific risk which could be economic, political or any other major event (remember country like China was hugely impacted by the former trade war with US or during outbreak of the Covid-19, Russia in the ongoing war with Ukraine), currency risk (fluctuations in the emerging market currencies against the US dollar can impact the return on investments), liquidity risk, inflation and interest rate risk and lastly regulatory risk (change in regulations which typically calls for the fund managers to rejig their portfolios as per the new norms). All these risk factors can lead to volatile performance of the emerging market funds especially in the short run.   

In addition, evaluate the tax implications before investing. Emerging market funds are considered as equity-oriented funds and hence the short-term capital gains from these funds are taxed at 15% while the long-term capital gains of above Rs 1 lakh is taxed at 10% without the benefit of indexation.  

Summing up

The pandemic blow and worries about global monetary tightening had a spillover on the emerging market in the recent times which has impacted the performance of the several funds investing in these countries. However, emerging market funds do offer an additional diversification opportunity to the investors. But they are most suitable to investors keen on earning higher capital appreciation in the long run and have a higher risk tolerance ability.