Should You Invest In International Funds?

For those who would like to look beyond investments into domestic equities, Mutual Funds offer investors the option to invest into international funds as well. Broadly, international funds can be slotted into three categories. The first kind invests 65 per cent into domestic equities and the remaining into international equities (for instance, Birla Sun Life International Equity Fund), and are therefore a great deal better in terms of tax efficiency, as their returns become tax free after a year. The second category invests through a 'feeder' mechanism into a specific country or region (for instance, Reliance US Equity Opportunities Fund). The third category invests in global stocks based on a specific theme such as gold mining, agriculture and energy (for instance, DSP BlackRock World Gold Fund). The second and third categories do not offer the tax efficiency that the first one does, as they are treated as debt instruments from a taxation standpoint.

How they have fared
Of the 70 odd international funds that exist today, only 8 have given a double digit return in the past year. The cumulative value of AUM's across international funds adds up to a fairly paltry figure, underscoring the fact that they haven't really gained much popularity till date. Of the 8 funds that did deliver positive returns last year, the stark outperformer was DSP BlackRock World Gold Fund, which rallied more than 60 per cent on the back of a strong uptrend of close to 13 per cent in global gold prices in the past year (gold stocks have an additional operational leverage effect when gold rallies). Go back three years though, and the annualized returns taper off to a more rational 15 per cent or so. US based feeder funds delivered flattish to negative returns in the past year, ranging from -5 per cent to 5 per cent, whereas China based funds were deep in the red with returns lower than -10 per cent, going as low as -20 per cent.

The Case for International Funds
In principle, International Funds might look like an attractive proposition on many counts. Proponents of International Funds tend to point out three things. First, they act as a hedge against a fall in the Rupee against the Dollar. Second, they create an additional layer of diversification by reducing exposure to Indian assets as a whole. Third, it may be assumed that more mature markets will be more stable, and hence an exposure to International Funds investing in say, the US, may reduce the overall risk and volatility in one's portfolio. Global markets also tend to be cheaper, trading at P/E multiples that are 3X-4X cheaper than Indian indices.

Sundeep Sikka - Executive Director & CEO - Reliance Nippon Life Asset Management Limited believes that the diversification benefit offered by International Funds make them worth considering. "International Funds help investors diversify their portfolio. Returns generated from such funds could be different (better at times) from that of domestic markets, and hence could help smoothen portfolio returns", he said.

The Case against International Funds
It's important to note that International Funds carry a unique set of risks. A combined fall in the currency as well as the equity market of the target country may cause a double whammy that impacts the fund's performance in unprecedented ways. Very often, these bouts of poor performance can stretch into years - classic examples being HSBC Brazil Fund, which has delivered a 5 year annualized return of -9 per cent per annum, and DSP BlackRock World Mining Fund, which has seen its NAV drop by close to 11 per cent year on year for the past five years, leading to significant long term losses for investors.

"Currency risk is an additional risk of investing into international funds. If the currency of the country you are investing into depreciates in value, it will have a negative impact on the overall returns", Sikka cautions investors.

A Final Word
Retail investors looking to invest for their long term goals are probably better off sticking to domestic equity funds and avoiding International Funds. At best, they should opt for the first category of International Funds that split their holdings between domestic and international equities (such as Templeton India Equity income Fund or Birla Sun Life International Equity Fund).

More savvy High Net Worth individual investors may consider International Funds for a 5-10 per cent allocation to their overall mutual fund holdings, but no more. In doing so, they might want to avoid the complex 'theme based' international funds which require timing and monitoring. Such funds may provide bursts of unprecedented high returns, followed by extended periods of non-performance, or vice versa. Such high levels of volatility usually lead to irrational decision making. It's vital to consider the taxation aspect while investing in International Funds. If tax efficiency is an essential requirement, you need to steer clear of most International Funds.

In conclusion, what International Markets are industry experts betting on right now? "Japan", says Sikka, "for having unleashed the three arrows to bring about economic growth: fiscal stimulus, monetary easing and structural reforms"