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Global funds have opened a window to international asset markets for Indian investors. They have made it easier for Indian investors to diversify their portfolios (and in this way de-risk them) beyond the conventional domestic equity and debt avenues.
Investing in global funds can also prove advantageous if you have a future liability in that currency/country. For instance, if you plan to send your child to the US for higher studies, investing in an US fund can be an option for you. By doing so you would have done away with the currency risk (explained later in this note).
Having said that, investing in global funds has its fair share of risks, which investors must evaluate. We present a checklist that will help you evaluate global funds and make an informed investment decision.
Factoring the expenses
Investors in mutual funds incur expenses at two levels. The first is a one-time expense (in the form of an entry/exit load) and the other is the recurring expense related to fund management expenses, market and sales expenses, administration expenses to cite a few. The recurring expenses are incurred by the mutual fund, but passed on to the investor. If you never realised this fact, it is because the daily NAV (net asset value) that is declared factors in the expenses.
It is equally important to evaluate a global fund from the 'expense' perspective. This is more so since many of the global funds that are being launched have opted for the FoF (fund of funds) route as opposed to direct investments in global markets.
While FoFs add the diversification edge to your portfolio, this comes at a cost. FoFs have a double-layered expense structure. So all expenses (one-time as well as recurring) are incurred twice in an FoF; first for the FoF itself and second for the underlying scheme.
Although the underlying schemes often waive off the entry load, there is still the matter of the FoF's recurring expense. While calculating the FoF's expense ensure that you add both the recurring expenses (FoF's plus that of the underlying funds) and both the loads (FoF's plus that of the underlying funds, if any).
The reason why investors have to be very concerned about the expenses incurred by their mutual fund investments is because over a period of time, higher expenses can and will erode returns significantly.
Don't ignore currency risk
Currency risk is one of the more vital factors associated with global investing. Let's understand this risk with the help of an illustration. Suppose you invest Rs 4,000 in a US$ fund. The Rs 4,000 will be converted into US$ 100 (approximating, for convenience).
This US$ 100 is then invested over a one year period; now assume you earned 10 per cent return i.e. the value of your investment is now US$ 110. But what is the value in terms of Indian Rupees? Let's again assume, that the India Rupee actually appreciates vis-a-vis the US Dollar and touches Rs 36 per US Dollar in a year.
So, effectively, the US$ 110 translates to Rs 3,960! So, even though in US Dollar terms you earned 10 per cent, in Indian Rupee terms you actually lost 1%! But this is just a hypothetical example to illustrate currency risk. The situation could reverse and your gains could actually be magnified.
In our view, investors can take on this risk under certain circumstances; for instance if you plan to send your child abroad for higher studies, then you can consider investing in a global fund domiciled in the country where your child will be studying.
Then there is country/market segment risk
Another type of risk related to the currency risk is the country/market segment risk. There is no doubt that by investing in global funds, investors get an opportunity to diversify their portfolio across countries, but the same also amounts to taking on country/market segment risk.
For instance, if a global fund invests in a particular country (say the US) or a market segment (emerging markets), then its investors are exposed to the negatives and positives of that economy (over here the US) or that market segment (over here emerging markets).
In our view, it is best to select a well-managed fund that can invest across global markets. That would be diversification at its best. Such a fund would give its fund management team the much-needed flexibility while deciding where to invest.
Check the track record of the underlying investments
Through global funds Indian investors are venturing into an investment universe to which they have had little or no exposure. Investing in an avenue without adequate information enhances the risk level of that investment considerably. Hence, it is advisable for investors to check the track record of the underlying investments of global funds (particularly in a FoF global fund), before investing in them.
At Personalfn, we are presently not capacitated to give a view on the underlying investments; hence we recommend that investors evaluate the underlying investments based on a rating wherever available (try Morningstar or Standard & Poor ratings for instance).
Ensure that you have an adequate investment time frame
We believe that investments in equities and related assets should be made with at least a 3-5 Yr investment time frame. In an open-ended global fund this should not be a problem because you stay invested for as long as required. But in a close-ended global fund you should consider funds that have an investment tenure of a minimum of 3-Yrs (preferably more than 3-Yrs) and if it is lower than that, then it is best to avoid such funds. For equity investments, longer the tenure, the better it is in our view.
Is it diversified adequately and appropriately?
Investors are meant to get the benefit of diversification by investing in global funds; hence it is surprising when global funds deprive investors of this benefit. Many of the global funds that have been launched (and are going to be launched) are investing predominantly in emerging markets, which to an Indian investor is not particularly exciting because India by itself is an important emerging market.
So by being invested in domestic markets, the Indian investor already has a flavour of emerging markets. Ideally, he wants to diversify by investing in other markets (like developed markets for instance) that behave differently vis-�-vis emerging markets. So go for global funds that invest across market segments.
At the other end of the spectrum are global funds that diversify excessively. For instance, Sundaram Global Advantage Fund invests across four asset classes, a) emerging market equities, b) real estate, c) commodities and d) domestic fixed income. In our view, investing in a scheme that aims to diversify across so many assets may not be easy to fit in a portfolio. It is best if investors can make distinct investments as far as possible based on asset classes.
Ensure that your India Portfolio is in place
While at Personalfn we are big votaries of diversification, this must not be aimless. We welcome the move to launch global funds and believe that investors must make the most of this opportunity by investing in them to diversify their portfolios (and in this way de-risk them).
However, first they must ensure they have an India portfolio consisting of well-managed funds with established track records and investment processes. Only then must they invest in global funds. Put simply, global funds must not be considered as a stand-alone investment, rather they must form part of a portfolio.
How much to invest in global funds?
Since global funds must be considered primarily for the purpose of diversification and asset allocation, they should not form a large chunk of your portfolio. Typically, such funds should account for a smaller portion of your portfolio (typically less than 10 per cent); the precise allocation can be assessed only after discussing the same with your financial planner.
Don't rush into investing in global funds
Like with investments in domestic funds, investments in global funds need to be evaluated thoroughly after drawing comparisons with comparable offerings. So avoid the urge to rush into investing in a global fund for whatever reasons (media hype, distributor's persuasion).
Evaluate a global fund across parameters (the investment proposition it offers, the fund's investment processes, long-term track record across market phases, especially the downturns) by comparing it with other global funds of a similar nature. And keep in mind that many open-ended global mutual funds are likely to be launched in the next several months. So don't just invest thinking you will otherwise be missing an opportunity. Invest only for the right reasons.
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