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Falling Rupee a Boon to Your Offshore Investments? - Outside View by PersonalFN

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Falling Rupee a Boon to Your Offshore Investments?
Jun 7, 2012

Falling Rupee is makings headlines these days. Despite the concerted efforts made by the Reserve Bank of India (RBI) and the Government to reign in the slide; Indian Rupee (INR) is hitting new lows against US Dollar (USD), almost every alternate day. Falling Indian Rupee is both boon and the bane for India; it only depends on how you look at it. Falling INR gives exporters a reason to cheer about; however, an importer can get sleepless nights as it increases the cost of goods imported. At the country level, India would want stability in the value of INR against the USD as it still imports about 80% of its crude oil requirements. Crude oil is denominated in USD in the international market. At the micro level falling INR may affect investors, particularly those who have exposure to international markets. So here our research analysts have studied how the offshore investments (especially through mutual funds) have fared when the INR is falling; but before getting there, let's first shed some light on cross currency movements and their impact on investors.

Falling Rupee and Rising Dollar

The chart below shows the movement of rupee against dollar over the last 5 years. On May 17, 2007, the US dollar which was quoting at 40.84 in terms of INR has appreciated by 33.2% over the past 5 years and was quoting at Rs 54.39 as on May 17, 2012 and is slowly heading towards Rs 60.

(Source: RBI; PersonalFN Research)

The INR has been depreciating sharply against the USD since August 2011 and has depreciated nearly 23% against USD in just 9 months. The similar movement was observed in 2008-09 when USD appreciated about 24% in 7 months starting from August 2008.

At this juncture it is more important to understand, how the other currencies are performing vis-a-vis the USD. Dollar index, which measures the performance of US dollar against the basket of some major currencies such as Euro and Japanese Yen, has appreciated by around 8.3% in last 1 year. On the other hand, US dollar has appreciated around 21.0% against Indian rupee over the similar time period. This indicates that the fall in Indian rupee is more pronounced as compared to other major currencies.

The reason for the rising US Dollar

Currently the US economy is not growing rapidly; the housing market has not yet picked to the pre-crisis level and the Federal Reserve (FED) is not in a mood to tighten the monetary belts any time soon. On this backdrop, the strength in US dollar is astounding. Despite the rating downgrades by Standards & Poor's in August 2011, the US dollar has emerged stronger. This mainly attributes to the deteriorating fundamentals of Euroz one economies and relatively promising recovery in US. Economic activities in Europe are contracting, unemployment rates are near all-time high for many of the countries, consumer confidence is badly shaken and political risk has been rising. Mounting sovereign debt in some of the member nations is putting enormous pressure on the European Central Bank (ECB) to contain the risk of default that may potentially ruin the entire European financial system and may also have a severe impact on the Global financial system. Contingent of sovereign debt crisis in peripheral economies of Europe such as Greece, Portugal and Ireland is threatening to spread all over Europe, thus making the job of ECB all the more difficult.

Country wise Sovereign Ratings by S&P
Country Local Currency Rating Foregin Currency Rating
France AA+ AA+
Germany AAA AAA
Greece CCC CCC
India BBB- BBB-
Ireland BBB+ BBB+
Italy BBB+ BBB+
Japan AA- AA-
Portugal BB BB
Spain BBB+ BBB+
Sweden AAA AAA
Swiss Confederation AAA AAA
States AA+ AA+
United Kingdom AAA AAA
(Source: Standard & poor's; PersonalFN Research)

It is clear from the table above that the creditworthiness of many European nations defers remarkably from one another. Countries such as Germany and Sweden are in a better shape and therefore enjoy the highest credit rating. On the other hand, credit ratings of countries like Greece, Portugal, Italy and Spain have been downgraded due to their poor fundamentals. Today, there are a very few nations that qualify to be considered as a safe investment destination; thanks to falling credit worthiness and rising stress in many asset classes.

Impact on Global Assets Prices

For the last two years, the fate of global equity markets has been linked to that of the European and US economy. Equity markets rise for constructive developments and fall with the re-emergence of stress in the developed nations. Such risk-on and Risk-off affects the movement of currencies across the globe. Excess volatility in domestic currencies and that in global commodity prices affects the fundamentals of emerging economies.

Offshore Investments by Indian Investors

With the depreciation in the domestic currency, the offshore assets tend to get costlier due to increase in exchange value as a result of high exchange rate. Though Indian Individual investors may find it hard to take high exposure into global assets, which may be out of their reach due to geographical and regulatory constraints; they do have an option to invest in an offshore focused mutual fund that can help them diversify their portfolios across economies and geographies. However, as depicted in the diagram above, no diversification seems to be working for them at the moment. The problem of Sovereign European crisis and edgy economic growth in US is threatening to affect economic progress of the rest of the world; all risky assets are moving up or down in tandem; so is the risk free assets such as US dollar and US and Germen treasuries.

Performance of some Major Global Indices
  Currency MTD 3M YTD 1 Yr 3 Yr 5 Yr
MSCI Emerging Market Index Local -7.4% -9.7% 1.3% -11.1% 7.8% -0.5%
MSCI Emerging Market Index USD -10.3% -14.7% 0.5% -18.8% 9.2% -1.7%
MSCI World Index (Ex-Europe) Local -6.8% -5.9% 3.0% -5.2% 9.3% -5.3%
MSCI World Index (Ex-Europe) USD -7.2% -6.3% 2.5% -5.5% 11.3% -3.6%
HSBC Global Mining Index USD -14.9% -21.9% -19.9% -32.1% 26.5% -16.1%
US Dollar Index (DXY) N.A. 3.3% 2.7% 1.8% 8.3% -1.9% -
BSE-200 Local -7.2% -12.3% 7.0% -11.9% 11.3% 2.8%
(Performance as on May 17, 2012)
(MTD: Month to Date: From May 01, 2012 to May 17, 2012)
(YTD: Year to Date: From January 02, 2012 to May 17, 2012)
(Source: ACE MF,MSCI, HSBC Research; PersonalFN Research)

Table above reveals that BSE 200, the Indian diversified equity index has closely followed returns generated by MSCI Emerging Market Index, in local currency terms, over last 1 year. MSCI World Index-Ex Europe has outperformed the emerging market index over the similar time period. However, the noteworthy point is Irrespective of the geographies, equity markets have fallen across the globe over last 1 year. The fall is more pronounced when reported in dollar terms since the USD has appreciated against almost all currencies of the world, while the Indian investors (investing in INR) who at the same time took exposure in global markets fared relatively better than the investors who invest in USD. It is noteworthy that the on-going global turmoil seems to have thrown mining and commodity stocks completely out of whack. HSBC global mining index has fallen more than the other diversified index. Let's now see how the offshore funds have performed.

Performance of Offshore Funds Vis-a-vis BSE 200
Scheme Name MTD 3 Months 6 Months 1 Year 3 Years 5 Years
Avg. Returns generated by Offshore Funds -6.9% -6.2% -1.3% -5.7% 11.1% 5.4%
BSE-200 -7.2% -12.3% -0.5% -11.9% 11.3% 2.8%
(Performance as on May 17, 2012)
(MTD: Month to Date: From May 02, 2012 to May 17, 2012)
(Source: ACEMF; PersonalFN Research)

The rupee has depreciated nearly 21% in the last one year. Despite of that the average returns generated by the offshore focused funds have been in negative, but we also cannot ignore the fact that many offshore focused funds have definitely got some advantage of INR depreciation and have managed to limit losses during this phase. For those who believe that rising dollar and falling rupee will automatically translate into gains on offshore mutual fund investments, they should not forget that it is just the setoff of exchange rate change that will favour offshore funds in such conditions which can reverse any time. The actual performance of offshore funds is a result of the performance of its underlying asset class in any investment destination. Most of the offshore funds available in India are either thematic or sector specific or are focused towards multi nations in a specific region; many offshore focused funds act as a feeder fund investing in offshore mutual funds. So the benefit of INR depreciation against USD and few other stronger currencies may not boost the performance of all the offshore funds.

You as an investor should not use offshore funds as a hedge to currency risk, but offshore funds should be opted by those who are looking to invest in offshore assets. It would be prudent to know the investment universe and investment mandate of the scheme you choose to invest in, as all the offshore funds may not turn out to be gainers when the INR is in a losing mood.

Now let's see which offshore funds gained and which ones turn out to be the losers when every other asset class has witnessed a loss in value.

Top 5 Offshore funds
Scheme Name 3 Months 6 Months 1 Year YTD MTD 3 Years 5 Years
Birla SL Intl. Equity-A (G) 6.2 11.4 7.0 6.6 -3.8 12.9 -
Mirae Asset India-China Consumption (G) -1.1 6.4 5.4 9.2 -5.5 - -
DWS Global Agribusiness Offshore (G) 4.5 8.2 3.8 7.3 -4.5 - -
Principal Global Opportunities (G) -1.1 5.6 2.9 5.9 -6.6 15.1 4.1
Fidelity Global Real Assets Fund (G) 1.2 7.4 2.9 4.4 -4.3 - -
BSE-200 -12.3 -0.5 -11.9 7 -7.2 11.3 2.8
(NAV Data: May 17,2012)
(Source: ACEMF; PersonalFN Research)

And the Bottom 5...
Scheme Name 3 Months 6 Months 1 Year YTD MTD 3 Years 5 Years
Birla SL CEF-Global Multi Commo (G) -10.0 -8.4 -12.9 -6.1 -8.6 2.4 -
Mirae Asset Global Commodity Stock (G) -11.4 -5.0 -14.6 -0.8 -8.7 9.6 -
DSPBR World Mining (D) -12.6 -10.4 -15.7 -8.5 -11.1 - -
AIG World Gold (G) -21.4 -26.7 -19.7 -21.5 -14.2 9.1 -
Birla SL CEF-Global Prec Metal (G) -21.8 -28.3 -20.6 -19.4 -14.7 -0.4 -
BSE-200 -12.3 -0.5 -11.9 7 -7.2 11.3 2.8
(NAV Data: May 17,2012)
(Source: ACEMF; PersonalFN Research)

Considering the performance of individual schemes over the past 1 year and YTD when the INR is respectively down by 21% and 2% vis-a-vis USD, the offer fund like Birla Sun Life International Fund-Plan A, has stood to be the top performing fund in the category of offshore funds over the 1 year time period. However, the 7% returns generated by the fund looks inadequate considering the 21% and 2% depreciation of rupee respectively over the past 1 year and YTD. This also makes it clear that the quantum of returns generated by offshore focused funds is not only related to the change in currency, but is a factor of underlying investment universe and asset and geographical diversification.3 out of the top 5 funds are thematic in nature. Interestingly, funds that are lying at the bottom of the performance table are all thematic and sector specific in nature. The commodity focused funds end up in bottom performers due to sell off in commodities across the globe. Clearly, some themes have worked and some themes have failed. Any positive returns generated by thematic offshore funds (due to depreciation in INR) are inadequate to compensate the risk involved in them.

International Investments - More complex than they look

Buying international funds when the INR is strong and cashing the gains when it depreciates against dollar may look appealing, as at first, it looks logical and obvious. However, in reality it is more complex than one would imagine.

Assume you had invested in Statoil ASA, a state run Norwegian company, on May 18, 2011 when the rupee was strong at 45.08 against dollar. Then the stock price per share was 143.2 Norwegian Krone (or 26.1 USD) on Oslo Stock Exchange. On March 14, 2012 the stock was quoting at 162.4 krone (or 27.8 USD); its highest price since you had invested. On conversion you would have made 17.9% profit (in INR terms) as at that time the INR was quoting at 49.9 against the USD. Out of the total profit that you would have made on your overseas investment; the 10.7% was the forex gain. On May 18, 2012 the INR depreciated to 54.87 against USD. However, you would now make only 7.2% gains on your investment in Statoil ASA. How? The stock price went down to 138.3 Krone (a 3.4% fall from your buying price) but the fall in USD terms was 11.9% (23 dollars per share). In other words, Norwegian Korne too, just like INR, depreciated (by around 9.7%) against USD . This explains that currency risk is just too a vital element to ignore while investing in offshore funds other than one focused towards US. And you cannot decide your entry and exit just based on the movement of your domestic currency vis-a-vis USD.

Take one more Example; it will be difficult to find a mining fund that doesn't invest in Rio Tinto which is global mining giant and is listed on London Stock Exchange. In last 1 year the stock has lost about 30%; a fall that would be difficult to arrest even with the favour able currency movement.

Our View

The recent fall in the value of Indian rupee has not resulted in spectacular gains for all India based offshore funds. The current global economic scenario has challenged many historical correlations that were held for long. The complications in the inter currency movement make the job of the fund manager managing an offshore fund extremely difficult. The risk-on and risk-off nature of today's trade is causing all risky assets to move in tandem and there is not much difference in developed equity markets and emerging equity markets as far as direction goes. Both move in the same direction to a greater or a lesser extent. Hence we believe that only those investors who have adequately diversified their portfolio across Indian assets can then consider investing in offshore funds. However, betting on offshore focused funds based on the movement of currency would just be a speculation. While investing in offshore funds, one should choose a fund that is truly diversified in nature and comes from a fund house that has a proven track record in managing global assets.

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


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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