In 2007, when the Indian economy and markets were both soaring, I witnessed the CEO of a fund house trying to peddle the idea of international investing at an investor’s forum. The poor gentleman was scoffed at. But investing in international markets enables you to diversify against the risk of being invested solely in your home market. By being diversified across segments, your portfolio benefits irrespective of which segment does well.
Hence, I recommend that high net worth investors dedicate at least 10 – 20 per cent of their equity portfolio to foreign markets. Besides, the central bank too has now liberalised rules and allows individuals to invest up to $200,000 [INR1.11 crore] abroad, annually.
What to look for?
When investing in a foreign fund, make sure that the market you are investing in has low correlation with your domestic market [you can check out the correlation between the leading indices of the two markets].
Next, just as in the case of domestic funds, international funds too can be ranked as follows in increasing order of risk: large-cap value [lowest risk], large-cap- growth, mid and small cap-value and mid- and small-cap growth [highest risk]. Check out the style box of a fund: invest in one whose risk profile you are comfortable with.
Choosing from the Indian bouquet
When you look at the bouquet of international funds available in India, what strikes you right away is that the list is tilted heavily in favour of funds that invest in gold mining companies, metals, commodities, energy-related businesses, agri-businesses, and so on. All these funds belong to the genre of sector/thematic funds that have narrow investment mandates. You should at best have only a small exposure to these funds or avoid them altogether because they are risky [commodities as an asset class are more volatile with cycles that are longer and deeper than those of equities].
Give priority to diversified equity funds that have the mandate to invest globally. If you are going to invest in two international funds, it might be a good idea to go with one that invests in a developed world market and one that invests in an emerging market.
In India, there also exists a class of funds that invests partly in domestic equities [65 per cent or more] and partly in international equities. The advantage of these funds is that they get more favourable tax treatment. They are treated as equity funds [no tax on long-term capital gains].
Pure international funds, on the other hand, are treated at par with debt funds. The only thing to watch out for is that part of the portfolios of these funds will overlap with the portfolios of the domestic funds you already own. Another issue is whether they will give you adequate exposure to international stocks.
It is true that with many Indian companies venturing abroad, your investment portfolio already has some global exposure. Nonetheless, it has become important to consciously evaluate international funds in search of greater diversification and risk adjusted returns.
Know the risk
International investing is a dual bet. One, you invest on the international asset class [equities or commodities] that you have invested in at home. Two, it is also a bet on currency movement. If your domestic currency depreciates vis-a-vis the currency of the market that you have invested in, you will benefit. This is happening currently: most international funds have gained in recent months due to the rupee’s depreciation. On the other hand, if your domestic currency appreciates vis-a-vis the currency of the international fund you have invested in, your fund’s performance will suffer.
On currency fluctuation, Morningstar [the rating agency] advises that you should invest in a fund that follows a consistent policy on currency hedging. Either the fund should always hedge or it should never do so. The reason: academic studies have shown that over the long term, currency hedging has little impact on an international fund’s returns, though over the short term, it can have a considerable impact.
This was first published in the July 2012 issue of Complete Wellbeing.
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