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Should You Prefer Offshore Funds Over Domestic Funds Now? - Outside View by PersonalFN

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Should You Prefer Offshore Funds Over Domestic Funds Now?
May 30, 2015

It has been found that, retail investors often enter equity markets when predominant rally is already over.  In April 2015, net investment of mutual funds amounted to a little over Rs 7,600 crore in Indian equities.  Although the domestic macroeconomic factors are docile and global headwinds are in play, domestic investors' are continuing to exude confidence resting hopes on Modi-led-NDA Government at the helm. As you may be aware, corporate earnings data for the last couple of quarters of financial year 2014-15 wasn't very encouraging...and has made market valuations appear even more expensive. The India Rupee (INR) recently touched 20-month low against U.S. Dollar (USD) as Foreign Institutional Investors (FIIs) have pulled out money from India, dumping Indian assets. This as a result, has led to Indian equity market descend while the bond yields have increased.

Outperformance of Offshore Funds...
  3 Mth (%) 6 Mth (%) 1 Yr (%) 2 Yr (%) 3 Yr (%) 5 Yr (%)
Category Average of Offshore Funds 2.6 3.1 8.0 9.7 10.2 8.4
Category Average of Diversified Equity Funds -2.7 2.6 28.7 30.3 26.0 14.9
(Data as on May 27, 2015)
Returns below 1 year are expressed in absolute terms, while those over 1 year are compounded annualised
About 140 diversified equity funds and close to 22 offshore funds have been considered while calculating category average returns.
(Source: ACE MF, PersonalFN Research)

Actively managed diversified mutual funds have collectively generated negative returns of -2.7% over last 3 months, while offshore funds have managed to post +2.6% returns on an average basis.

So, are offshore funds becoming more attractive now and should you invest in them?

The weakness in the INR against the greenback (or USD), has aided offshore funds to do better in the last 3 to 6 months. But that can't be a sole factor to determine the return potential of offshore funds.

Movement of other currencies against USD and performance of foreign equity markets are some of the other deciding factors. At present the good performance of offshore funds can be mainly attributed to:

  • Depreciating Rupee;

  • Loss of steam in the equity Indian market; and

  • Other major equity markets of the world having performed better
But what is to be noted here is, over the longer time frames, offshore funds have lagged and diversified equity funds have performed far better!

Where is INR heading?

As FIIs exit India, the INR is likely to be under pressure. But the situation doesn't appear to be as scary this time as it may perceive to be. Now that CPI inflation has mellowed down to 4.87% in April 2015, the Real Effective Exchange Rate (REER) may show resilience. But the gains would be gradual. REER is the inflation adjusted value of the currency factoring in the inflation differentials among trading partners. India's REER was trading strong against the most major currencies in the world - and that's one of the reasons why INR hasn't witnessed a vehement fall against the USD, when compared to other major currencies. As reported by Bloomberg on February 10, 2015, INR was overvalued by huge 24% against the currencies of India's top 6 trade partners on trade-weighted inflation adjusted basis.

To arrest the sharp rise in the value of INR, RBI has been buying USD incessantly for last one year. RBI bought USD 82 billion in the calendar year 2014 and the trend of buying dollars by RBI is getting extended even in 2015.
Going forward value of INR would be impacted by...

  • The monetary policy stance of Federal Reserve in the U.S.;

  • Foreign capital flows in Indian capital market;

  • Prices of commodities, especially the ones India heavily imports; and

  • Trade and current account deficits
The verdict:

There are a few events such as default risk of Greece or monetary policy stance of European Central Bank (ECB) or that of the Federal Reserve in the U.S. that may affect global markets in varying degrees. Also political shifts in a particular nation would affect, but the impact is likely to restricted domestically. This suggests it's challenging to run an offshore fund successfully. Moreover, quite a few offshore funds offered in India are sector and thematic ones which carry huge risk.

In today's context, Indian market may continue to remain unattractive to FIIs until valuations do not appear realistic and corporate earnings don't rise noticeably. The Government has to deliver on its promises too, to keep the market sentiment strong.

In comparison, a few other markets in the world may look attractive. Thus there are likely chances of INR depreciating further and Indian market remaining unattractive for some time now. Such a situation may be conducive for offshore funds. However, the complications in the inter currency movement makes the job of the fund manager managing an offshore fund extremely difficult.

PersonalFN believes that ideally investors should stay away from investing in offshore funds. Only if one has a very high risk appetite and want to diversify the portfolio geographically, offshore funds can be considered. While investing in offshore funds, choose a fund that is truly diversified in nature and comes from a fund house that has a proven track record and investment processes and systems in place while managing global assets. But it should be noted that pure offshore funds aren't tax efficient.

On the other hand diversified equity funds are tax efficient, if held for the long term and have clocked appealing returns (as cited above) over longer time frames. But while selecting diversified equity funds prefer funds having a consistent track record and the ones which follow strong investment processes and systems.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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