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Globe Trotting: A Look At Globally Focused Funds in India
January 28, 2010

This article takes a closer look at how globally focused funds can be used by investors in India to diversify and build a global portfolio


Author : Dhruva Raj Chatterji



Untitled Document

Key Points

  • Global markets made a turnaround in 2009 due to improving economic fundamentals and upward revision of earnings growth. Emerging markets led the pack and received strong inflows.
  • According to the World Bank, GDP growth for developing countries is expected to be more robust at 5.2% in 2010, up from 1.2% in 2009. GDP growth for rich countries is expected to rise 1.8% in 2010 compared to a contraction of 3.3% in 2009.
  • Presently the overseas investment limit for mutual funds in India is $7 billion.
  • However the assets managed by globally focused funds stood at only Rs. 7,259 crores ($1.55 billion) at the end of 2009, still quite far away from the total overseas investment limit of $7 billion allowed by the government.
  • Global funds investing in commodities stocks, emerging market stocks and gold mining stocks and have managed to outperform over the last one year. The top performing global fund in India over a one year period is Mirae Global Commodity Stocks Fund.
  • The biggest benefit of a global fund is one of geographical diversification.
  • The biggest disadvantage of global funds in India is that presently funds investing primarily in foreign securities (even equities) and fund of funds (FoF) schemes are recognised as debt-oriented funds by the taxman in India. Thus they lose out on the beneficial capital gains tax treatment of equity-oriented funds.
  • Global funds are also subject to currency risk.

 

Global Markets Make A Turnaround in 2009

The global financial markets witnessed testing times with the surfacing of the subprime crisis. However, the year 2009 marked a turnaround for markets worldwide with economic fundamentals improving and stronger earnings growth outlook. Appetite for equities resurfaced in 2009, with investors flocking back to the asset class after risk aversion in late 2007 and 2008. Emerging markets led the recovery with Latin America and Emerging Europe topping the charts in 2009, and Asia ex Japan following close behind. Emerging markets have been receiving a lot of attention and foreign fund flows lately, with strong growth prospects, improving fundamentals and rising domestic consumption. Our favourite region for 2010 is Global Emerging Markets. The valuations of some of the emerging markets are also reasonable with major representatives like Brazil, Russia and Israel trading at P/E Ratios of below 14X. Rising inflationary expectations is also expected to benefit the resource rich countries like Brazil, Russia and Indonesia. Earnings growth for this region is expected to be 29% in 2010 and around 18% in 2011. (Refer to Table 1 for Performance, Valuations and Earnings Growth of Key International Indices).

On the economic front too GDP growth for 2010 is forecasted to improve, compared to a disappointing 2008 and lackluster 2009. According to the World Economic Report released by the IMF (International Monetary Fund) in October 2009 GDP growth for advanced economies is expected to expand by 1.25% in 2010 compared to a 3.5% contraction in 2009, while for emerging economies, real GDP growth is forecast to reach almost 5% in 2010, up from 1.75% in 2009. On similar lines, the recently released Global Economic Prospects 2010 report by the World Bank cites that GDP growth for rich countries is expected to pick up to 1.8% in 2010 after declining by 3.3% in 2009. Meanwhile prospects for developing countries are more robust in 2010, with them expected to grow 5.2% this year—up from 1.2% in 2009.

Table 1: Performance, Valuations and Earnings Growth of Key International Indices

Returns are based on index levels as at 15 Jan 2010 (in Local Currency Terms)

Change since 30 Dec 2009

2009
Returns

2008
Returns

P/E Yr 2010

P/E Yr 2011

Earnings Growth 2010 (%)

Earnings Growth 2011 (%)

USA (S&P 500)

0.90%

25.80%

-38.50%

14.5

11.9

27.5

22.3

Europe (DJ Stoxx 50)

1.30%

29.30%

-45.60%

12.3

10.2

25.3

20.5

Japan (Nikkei 225)

4.10%

24.00%

-42.10%

17.1

13.5

82.8

26.2

Emerging Markets (MSCI EM)

3.10%

78.30%

-54.50%

11.8

9.9

29.0

18.4

Asia ex-Japan (MSCI Asia ex-Japan)

3.10%

71.70%

-53.60%

14.0

12.0

29.7

16.7

Singapore (STI)

1.00%

65.10%

-49.20%

13.8

12.7

29.0

8.9

Hong Kong (HSI)

0.70%

50.50%

-48.30%

13.7

11.1

21.1

23.5

Taiwan (Taiwan Weighted)

3.00%

82.00%

-46.00%

18.6

15.8

56.3

17.2

South Korea (KOSPI)

1.10%

51.30%

-40.70%

10.4

9.2

36.7

13.2

China (HS Mainland Composite Index)

2.20%

53.80%

-48.90%

13.5

11.6

20.8

16.6

Malaysia (KLCI)

2.20%

48.10%

-39.30%

14.5

12.7

12.8

14.4

Thailand (SET Index)

1.60%

65.90%

-47.60%

11.4

9.9

13.5

14.5

India (SENSEX)

1.20%

82.00%

-52.90%

16.3

13.7

23.4

18.6

Indonesia (JCI)

4.40%

95.30%

-50.60%

14.0

11.7

17.9

19.7

Source: iFAST Financial Compilations, Bloomberg

 

Globally Focused Mutual Funds: A Convenient Tool for Building a Global Portfolio

For the average Indian investor, international avenues are still a relatively unexplored territory. However, the ease in overseas investment norms for mutual funds has now made it possible for the retail investor in India to participate in international markets and add a foreign flavour to one’s portfolio. The central bank in India increased the overseas investment limit for mutual funds in India to $7 billion in April 2008 (from $5 billion at the end of 2007), with an individual fund house limit of $300 million. These steps were taken by the central bank to move towards greater capital account convertibility and also to rein in the appreciation of the rupee due to record high foreign inflows in 2007.
 
The Indian government took the first step of relaxing overseas investment for mutual funds in January 2003 by increasing the limit from $500 million to $1 billion. However, investment was only allowed in shares of those overseas companies, which had a shareholding of at least 10% in an Indian listed company (also known as the 10% reciprocal shareholding rule). This dramatically reduced the investment universe of mutual funds to shares of only a handful of international companies, thus limiting their attractiveness. The government later removed the 10% reciprocal shareholding rule and also increased the overseas fund investment limit in tranches to $7 billion presently. The first global fund to be launched in India was Principal Global Opportunities which was earlier restricted to only a handful of stocks due to the 10% reciprocal shareholding rule, but now invests into another emerging market fund of the parent fund house. The assets of the fund have grown, but not substantially, rising from about Rs. 70 crores at its launch in April 2004 to touch a high of Rs. 651 crores in October 2007, and presently stand at about Rs. 146 crores at the end of 2009.
 
The relaxation of limit has helped asset management companies in India to increase assets managed by such funds, prompting others to also join the bandwagon and launch similar schemes. In 2007, a total of 10 such equity funds (excluding institutional plans) were launched which focused on international markets. In the year 2008, 12 funds were launched that invested abroad, followed by only 4 fund launches in year 2009. However the assets managed by globally focused funds stood at only Rs. 7,259 crores ($1.55 billion) at the end of 2009, still quite far away from the total overseas investment limit of $7 billion allowed by the government. (Refer to Chart 1 for Assets and Number of Globally Focussed Funds in India)

 

Chart 1: Assets of Globally Focussed Funds Still Far Away From Their Investment Limit

global_chart1_final

Performance of Globally Focused Funds In India

Presently a variety of globally focused funds are available, which not only invest in equities but also participate in other asset classes like gold, real estate and commodities. Besides this, there are global funds concentrating on certain key markets like China, Latin America and other emerging markets. Many of the funds use the Fund of Funds route for investing abroad, by investing in a global fund of the parent fund house abroad. Some even invest directly in international stocks. Table 2 highlights the performance of some globally focused funds in India. It can be seen that funds investing in commodities stocks, emerging market stocks and gold mining stocks have managed to outperform over the last one year. The top performing global fund in India over a one year period is Mirae Global Commodity Stocks Fund, which has a mandate to invest upto 35% of its portfolio in stocks of commodities and related companies in India and at least 65% of the portfolio will be invested overseas in Asian and Emerging Markets. The second best performing global fund was Fidelity International Opportunities Fund which is not a pure global fund, as it has a mandate to invest only upto 30% in international markets (biased towards Asia ex Japan) and at least 65% must be invested in Indian equities. Both these funds invest internationally through stock directly and not via the feeder fund route.

Table 2: Performance of Globally Focused Funds in India

Fund Name

Perf. Figures based on Prices as at

1 mth
(%)

3 mth
(%)

6 mth
(%)

1 yr
(%)

2 yr
(%)

MIRAE ASSET GLOBAL COMMODITY STOCKS FUND- GROWTH

18-Jan-10

6.06

6.34

34.39

106.25

-

FIDELITY INTERNATIONAL OPPORTUNITIES FUND- GROWTH

18-Jan-10

5.18

6.60

28.43

94.10

3.10

ICICI PRUDENTIAL INDO ASIA EQUITY FUND RETAIL- GROWTH

18-Jan-10

3.63

4.75

22.94

88.35

-1.81

AIG WORLD GOLD FUND- GROWTH

14-Jan-10

0.39

2.49

33.97

73.62

-

BSL INTERNATIONAL EQUITY PLAN B-GROWTH

18-Jan-10

4.28

3.95

20.88

73.15

-5.61

PRINCIPAL GLOBAL OPPORTUNITIES FUND- GROWTH

14-Jan-10

1.41

3.57

28.35

64.29

-3.14

HSBC EMERGING MARKET FUND- GROWTH

18-Jan-10

2.40

-0.31

16.46

64.18

-

DSP BLACKROCK WORLD GOLD FUND - REGULAR PLAN - GROWTH

15-Jan-10

-0.59

-1.02

19.52

63.78

0.91

SUNDARAM GLOBAL ADVANTAGE FUND- GROWTH

11-Jan-10

2.82

7.14

31.59

60.52

-0.84

FT ASIAN EQUITY- GROWTH

18-Jan-10

2.48

3.11

12.24

59.74

4.31

BSL COMMODITIES EQUITIES FUND GLOBAL MULTI COMMODITY PLAN RETAIL- GROWTH

18-Jan-10

3.70

3.69

18.53

35.41

-

DWS GLOBAL THEMATIC OFFSHORE FUND - GROWTH PLAN

13-Jan-10

2.29

3.21

15.68

28.85

-7.42

BSL INTERNATIONAL EQUITY PLAN A -GROWTH

18-Jan-10

-0.24

1.19

11.56

27.73

-3.67

TATA GROWING ECONOMIES INFRASTRUCTURE FUND PLAN B- GROWTH

18-Jan-10

5.22

2.51

29.17

-

-

TATA GROWING ECONOMIES INFRASTRUCTURE FUND PLAN A- GROWTH

18-Jan-10

3.46

2.69

25.51

-

-

DSP BLACKROCK WORLD MINING FUND- GROWTH

15-Jan-10

5.32

-

-

-

-

Source: iFAST Financial Compilations
Returns greater than 1 year are Compounded Annualised. Data sorted on the basis of returns of 1 Year

 

Benefits and Limitations of Globally Focused Funds

The biggest benefit of a global fund is one of diversification. It allows the investor to diversify his / her portfolio geographically. All markets go through periodic cycles. There is no certainty that a particular market performing well presently will continue to outperform in the future too. Table 3 highlights the performance of some key international markets. It can be seen that China was among the top performing markets in 2006 and 2007, but was a bottom performer in years 2003, 2004 and 2005. Thus a globally focused fund will help to reduce the diversification risk of an investor and at the same time follow a professional approach of investing their funds with the requisite expertise in international markets.
 
However, investors in these global funds need to take note of some apparent drawbacks too. One of the biggest disadvantages of these global funds is the unfavourable capital gains tax treatment of these funds, as compared to other traditional mutual funds in India. Presently, funds investing primarily in foreign securities (even equities) and Fund of Funds (FoF) schemes are recognised as debt-oriented funds by the taxman in India. Thus they lose out on the beneficial capital gains tax treatment of equity-oriented funds. Equity oriented funds are presently subject to a short term capital gains tax of 15% (plus surcharge and cess) while long term capital gains is exempt from taxation. However debt-oriented funds are subject to long term capital gains tax of 10% (without indexation) and 20% (with indexation). Short term capital gains of debt-oriented funds are taxed at the applicable tax rate. To escape this apparent drawback, some mutual funds in India restrict the overseas exposure of their funds to 35% of the portfolio, and invest the balance 65% in Indian equity holdings, thus enabling the fund to be recognized as an equity-oriented fund by the exchequer.

The other threat to global funds is the currency risk, which could at times erode a substantial part of the original gains.

Table 3: Changing Fortunes! - Year-Wise Performance of Key Markets

global_table3_27jan10

 

Conclusion
 
At present, the overseas investment limit of mutual funds in India  is far from exhausted, indicating that Indian investors have still not fully caught on to the concept of borderless investing. But going forward, as the Indian market opens up and matures, global funds are likely to find wider acceptance amongst portfolios of Indian investors. The Indian government also has to extend tax benefits to these funds to bring them on the same level of other traditional mutual funds (enjoying tax benefits) and thus make them more acceptable to investors. With the Indian markets having run up significantly in the past year, valuations are starting to look rich in some pockets. Through the global funds route an investor can look in participating in international and emerging markets that look more attractive to India from a valuations and earnings growth perspective. Thus the crucial ‘geographical diversification’ benefit of these funds discussed above is reason enough for these funds to command a marginal allocation in every mutual fund portfolio.
 
Use the Fund Selector tool to view the global funds available on our India platform.


iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.

 


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