Why Indian investors show interest in global Funds to invest

Diversification is the golden rule of the investment planning. Why diversify or spread investments across asset classes i.e., equity, debt, gold or cash?

Why Indian investors show interest in global Funds to invest

Diversify globally with international funds

Diversification is the golden rule of the investment planning.  Why diversify or spread investments across asset classes i.e., equity, debt, gold or cash? Because, risk is the inherent aspect in any of the investments and performance of the asset classes tend to vary across different time frames.  So, when investors diversify, they can mitigate risk as likelihood of the potential loss posed by one asset class can be offset or reduced by the growth opportunities of another asset class in the portfolio.  Investors can diversify easily with the help of the domestic mutual funds which offer different categories of funds such as equity, debt, liquid or gold funds. Further, with the globalisation and integration of the financial markets’ investors can also invest in the international funds which gives exposures to foreign companies and economies.   Investors who have well diversified portfolio in the domestic market get one more opportunity to invest in different geographies and markets thereby earn higher returns but by taking higher risk.  

Decoding International funds

Mutual fund houses in India offer international funds which mainly invest in the in the equity, equity related instruments of companies listed outside India. Note, few global funds invest in domestic as well as international markets.  Most of the international funds in India are equity-oriented funds with very smaller exposure to debt instrument or cash. Typically, there are two variants – some are actively managed funds which invest directly in stocks of foreign entities like for instance in US companies while other funds buy units of the funds that in invest in such global companies. The latter is known as Feeder Fund or Fund of Funds (FoF).  There are total of 44 international funds in India wherein domestic AMCs themselves actively manage only 6 schemes while the remaining 38 funds are managed using a fund of funds (FoF) structure.  The asset under management (AUM) stood at Rs 15,779 crore. Investors should do their due diligence before investing as these data is only for the reference purpose.

Attractiveness of the international funds for Indian investors

Some of the vital merits of the international funds are as follows:

  • Diversify globally across different economies and financial markets - One of the key advantages of international funds is the global diversification wherein investors can diversify across developed and developing economies of the world. Exposure to different economies helps to manage risk efficiently due to low correlation as the growth patterns and performance of the financial markets of the developed and emerging economies tend to vary at times. For instance, in the calendar year 2016, US benchmark index Dow Jones rose 12% and Brazil’s Bovespa index surged 33%. However, back home Indian equity benchmark – S&P BSE Sensex rose only 4%.  Hence, an investor taking exposure to international funds could have benefited from the better performance of the global markets.

 Within international funds, there are many varieties like some funds have exposure to specific countries such as US, Japan, Brazil and Hang Seng or set of economies such as Asian, Association of Southeast Asian Nations (ASEAN). Further, within international funds investors can choose to invest in funds catering to certain sectors like agriculture, consumer, energy or mining or themes such as asset allocation, climate change. There are exchange traded funds as well which helps to replicate the underlying constituents of the global indices such as NASDAQ, S&P 500. (See chart)

Variants of international funds

  • Diversification across currencies – International funds enable investors to protect their money against rupee depreciation. The potential returns are likely to increase whenever there is appreciation in the value of the foreign currency against the home currency (in case of India it is rupee) and help to protect the money against devaluation.  For instance, one invested Rs 5000 in an international fund in May 2017 when the value of 1 USD against the INR was Rs 63.98^.  So, the cost of the investment comes at Rs 3.2 lakh, note we have not considered any other expenses involved.  In the following 5 years as the value of the rupee depreciated against the dollar and rupee stood at Rs 72.93^ against the dollar in May 2021 the value of the investment tends to increase to Rs 3.64 lakh. Example is just for the illustrative purpose to give an idea on how one can benefit from the currency fluctuations. Note there are several country specific events and other factors that impact the funds’ performance.
  • Professional management of the international portfolio - Individual investors may not have the expertise to identify, track global markets and economies. Individually managing the portfolio of the foreign companies can be daunting task. Hence, investing via mutual fund route leads to fund manager managing investors’ portfolio. These fund managers are backed by strong research team, themselves have the experience, qualification, exposure to global markets and know the art of stock picking resulting in efficient management of the portfolio.

Apart from the aforementioned benefits investors should note that international funds are taxed as debt funds in India.  Capital gains for the funds held for less than 36 months are taxed as short-term capital gains tax where tax is applicable as the income tax slabs.  Long term capital gains tax is applicable to the investments held for the period of more than 36 months and taxed at 20% plus indexation.

Beware of the risk factors

We all know mutual funds are subjected to market risk and international funds too are exposed to following risks:

  • Economic and geopolitical risk – While international funds provide opportunity to invest across the globe but at the same time it makes the performance of these fund vulnerable to several economic and geopolitical events that might occur in different economies.
  • Global financial market volatility – Fluctuations in the global financial markets due to several factors like policy stance of the US Federal Reserve, Chinese economic slowdown, US-China trade war or sector specific events like fluctuations in the global crude prices or sell off in the US technology stocks are some of the factors that often impact the funds performance.
  • Currency fluctuation risk – While international funds help to diversify across different currencies, investors should note that if the rupee appreciates against the US dollar then investors can earn lesser rupees for every dollar invested. For instance, USD-INR rate was Rs 72.61^ in October 2018 and in April 2019 it was Rs 68.38^ which might have adverse impact on the investments.
  • Cost involved – Investors should note that international funds which are funds of funds have separate fund management expense fees of both the feeder fund and the underlying fund. So investors need to check the fund related documents and evaluate the cost involved before investing.

Hence, before investing one should take a note of these risk factors and also invest in line with the risk-return profile. Note international funds are high risk funds and suitable to investors who have higher risk-taking capacity and have good understanding of the mutual funds with well diversified portfolio back home.  Investors can either do lump sum investment or start a systematic investment plan (SIP) with later adding lot of discipline and negate the risk of market volatility. Investors can seek the help of the financial advisors to choose the funds wisely by carefully studying all the portfolio attributes, investment style, track record and cost involved.   Lastly, note international funds are equity oriented funds and hence stay invested for the long term to create wealth by diversifying globally.