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Diversification with International Funds

The Indian markets have been volatile and uncertain since 2010. However, the global markets have done well in certain geographies. Investment in international markets is available in India. The options vary from only geography based to theme based and asset class based. Read this space to know more about International Mutual Funds.

April 23, 2013 / 05:21 PM IST

The Indian markets have been volatile and uncertain since 2010. However, the global markets have done well in certain geographies especially with the resurgence of US markets. With Europe going through economic turbulence, it might be offering buying opportunities for several companies and a few geographies now. The strengthening of US dollar has also helped many stocks along with geo-political stability.

Diversification is a proven strategy to shock proof your portfolio and enhance returns on your investments. If you have a well-diversified portfolio in Indian mutual funds, you may choose to explore investments in international funds to diversify your portfolio further taking advantage of global economic factors. As no geography performs consistently well every year, having a global exposure through mutual funds across geographies can benefit investors a lot.

Investment in international markets is available in India. The options vary from only geography based to theme based and asset class based. We have a plethora of choices for an investor to offset risk due to domestic markets by taking exposure to international markets through mutual funds. There are several international funds that also offer investment opportunities in some of the top global companies. For example the NASDAQ fund has exposure to 100 global companies that provide for diversification in investment style and number.

Let’s look at some of the merits of investing in international funds.

  • Broader access to specialised markets: Investing in international funds gives you a chance to invest in areas that are normally inaccessible to you. For example, you could be bullish on gold and would want exposure to gold-mining companies based in Australia. A gold-mining international fund would make the perfect fit for your portfolio. Another example, If you are bullish on the growth prospects of technology companies like Apple, Microsoft, Oracle, Cisco and Google, a NASDAQ ETF would be the preferred choice.
  • Diversification: As stated above, investing in international funds offers diversification. So if oil prices shoot through the roof, it may be bad news for an importing nation such as India, and thereby Indian stocks, but an international fund that invests in stocks of resource-rich Brazil could offer you some respite.
  • Hedge: A well-diversified portfolio works as a good hedge. As an example, in 2011, the Indian market ended the year down over 20% but the U.S. market closed about flat. An investment in Motilal Oswal’s Nasdaq 100 ETF would have netted positive returns not just because of the difference in performance of both countries’ stock markets but also because the Indian rupee fell while the dollar rose during the period. (Currency movement, however, can also be a risk as explained below.)

Let us look at the options of global investing. There are a variety of international funds available to investors in India. These funds can be broadly categorised into three types that help Indian investor get exposure to international markets.

Risks: Investments in international funds can be tricky as each fund is different in terms of the investment mandate and portfolio composition. Broadly the risks enumerated below must be analysed before one takes an exposure to international markets.

  • Currency risk: Foreign exchange risk is a primary reason to be cautious when investing in global funds as it can work for an investor both ways. Even if a global fund nets positive returns for a specific period, if the local currency of the country it is investing in goes down against the rupee, it could wipe out your gains.
  • Tax treatment: In terms of taxation, capital gains arising from investing in pure global funds are taxed at a higher rate than domestic mutual funds. For all funds that have less than 65% exposure to domestic equity are treated as debt funds for the purpose of taxation, which means both short-term and long-term tax is applicable when the investments in these funds are redeemed. However considering the returns of some of these funds in last few years, given the rupee depreciation against dollar and global economic stability is select geographies, the cost incurred through taxes has been worth the returns given by the funds.
  • Lack of research: Most global funds launched in India are of the fund-of-fund structure where the Indian fund invests into either one feeder fund set up abroad (which invests according to its mandate) or in a basket of underlying international funds. An Indian investor may not have the accessible research to gather adequate information about the underlying global fund(s) to determine if they fit his/her portfolio.
  • High expenses: Because of fund-of-fund structure that exists generally, global funds may have a higher expense ratio due to the dual nature of management expenses involved at the local and international levels.

So, one should carefully assess the risks before taking an exposure to international markets through mutual funds. Your portfolio might be diversified already, but if you would like to capitalize on changing global economic scenario and can anticipate the currency movements, then global investments in your portfolio may give you a return kicker and hedge as well.

The author is a member of The Financial Planners’ Guild, India (FPGI). FPGI is an association of Practicing Certified Financial Planners to create awareness about Financial Planning among the public, promote professional excellence and ensure high quality practice standards.

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