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5 points you must know before investing in global funds - Outside View by PersonalFN
 
 
5 points you must know before investing in global funds

Many investors in an aim to diversify their portfolio across geographical boundaries invest in global funds. It is noteworthy that the exuberant bull phase of the equity markets prior to the emergence of the sub-prime mortgage crisis introduced several investors to global funds; as mutual fund houses launched global funds - some focusing on the Indian-China story, while other taking the broader perspective of international opportunities.

While global funds have opened a window to international asset markets for Indian investorsand facilitateddiversification(beyond the conventional domestic equity and debt investments); it is vital to recognize the risk involved while investing and also be cognizant about other aspects before investing in them. Herein below are the points you must know:

  1. The risks involved

    Yes, before investing it is important to be well aware about what are the risks involved while investing in global funds. Broadly global funds expose you to following types of risks, which are:

    • Countryspecific macro-economic risk: Since such fund facilitates diversification beyond boundaries of one's home country, the primary risk involved is the country or market segment risk; wherein you are exposed to all the macro-economic risks of the foreign country, where you have decided to invest your hard earned money. For instance, if a global fund invests in a particular country (say the US) or a market segment (emerging markets or developed markets), then you as an investors need to be well-versed and ready for exposure to risk inherent to a developed market such as the U.S.

    • Currency risk: Currency risk too is one of vital factors associated with global investing.A country's currency is vulnerable to appreciation or depreciation depending upon demand and supply mechanism of course, but also the policy stance taken by the Government and their central / federal bank. The financial health of the economy is also a matter of concern for the currency to pave its path.

    Let's understand the currencyrisk with the help of an illustration. Suppose you invest Rs5,000 in a U.S. oriented globalfund. The Rs5,000 will be converted into U.S. $92.59(assuming a rate of Rs/U.S.$ of 54.00) as on the date of investment. This U.S. $92.59 is then invested over a one year period and assuming you earn 10% return, the value of your investment (of U.S. $92.59) fetches a sum ofUS$ 101.85. Now to obtain your value in Indian rupee terms, say the Indianrupee actually appreciates to Rs 52.00 against the U.S.dollar. In such a case the value of your investment (of U.S. $92.59) would fetch you Rs 5,296.30 - a gain of mere 5.9% in Indian rupees, as against the 10.0% gain, in dollar terms.This is known as currency risk. But this is just a hypothetical example to illustrate currency risk. The situation could reverse and your gains could actually be magnified.

    • Regulation risk:Sometimes the regulatory environment also acts as an impeding factor, even though the country offers strong growth potential as an investment destination. This is because investment in foreign securities is subject to nature of securities market and the transaction procedures of the relevant country. The liquidation of investments may also have an adverse impact on the performance of the scheme.

    • Geopolitical risk:Likewise one also needs to be cognisant about the geopolitical environment as it depicts its impact on the investment climate.It is noteworthy that geopolitical risk refers to risk emanating from political situation in a respective country or a region, and has a bearing on the macro-economic environment as policies are framed in the political lobbies which thus couldimpact the fortune of a global fund.

  2. Check the track record of the underlying investments

    If you are tolerant of the aforementioned risk, then you can budge and buy into a global fund. But you need to check the track record of the underlying investments. This is because investing in an avenue without adequate information could expose you to a considerable amount of risk
    It is noteworthy that, in the past - during the exuberant phase of the equity markets, investors bought global funds in excitement, but felt the jitters when these funds were battered in the global economic crisis.

  3. Is it diversified adequately and appropriately

    Yes, you must also check whether that the global funds you vie to invest in, is offering you adequate diversifications. Within the country your taking exposure to, it is imperative for you which themes / sectors the fund has exposure to - and that the fund does not hold a "portfolio concentration risk". Likewise amongst the global funds, there are some which have exposure to particular regions or markets, for example Asian markets, emerging markets, broader global markets; and thus therein is a need to peep into in what composition of the total asset allocation, where will the fund invest in respective countries within that region or markets, etc. For instance, if you decide to invest into a fund which holds a proposition of investing in the "emerging market", but discover that a major composition of the total assets under the management of the fund will be invested in India; here it may prove to be futile to invest in such a fund because the flavour and synergy may be found by investing in a domestic mutual fund itself which is India focused.

    On the other hand, if a global fund that diversify across global markets well could be considered, since it offers effective diversification across regions and markets.

  4. Factor the expenses

    You also need to take into the account the expense ratio and exit load charged by a respective global fund. This is more so for global funds which are launched as Fund of Funds (FoF) scheme as opposed to direct equity investments in global markets. It is noteworthy that 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 a FoF - first for the FoF itself and second for the underlying scheme.

    The reason why you should be concerned about the expense ratio charge by the fund is because over a period of time, higher expenses can erode returns significantly.

  5. Ensure that you have an adequate investment horizon

    We believe that investments in equities and related assets should be made with at least a 3 to 5 year investment horizon. In fact the longer the investment horizon, the better it is in our view. But having said that, it is imperative to review your portfolio wisely and take prudent actions thereto. This is because a review could preclude your portfolio from bleeding (in case it is) or could facilitate you to book profits if the fund has delivered well.
The end note...

Before you invest in global funds you need to ensure that your India Portfolio is in place. While we at PersonalFN are big votaries of diversification, this must not be aimless. We welcome the move to launch global funds and believe that investors cantake the 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.

So, how much to invest in global funds?

Well, since global funds can 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%); the precise allocation can be assessed only after discussing the same with your financial planner. Thus don't rush into investing in global funds. Evaluate thoroughly after drawing comparisons with comparable offerings and 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 doing a prudent comparative study.

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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