Looking to invest in MNC funds? Weigh risks properly before doing so

This category, however, tends to underperform when the market favours growth, high-beta or cyclical stocks

The MNC (multinational companies) category of thematic funds is currently in the spotlight as ICICI Prudential Mutual Fund has launched a new fund offer (NFO) for a fund in this category (NFO closes on June 11). Three funds—from Aditya Birla Sun Life, UTI and SBI—already exist in this category. Though the MNC category has been underperforming over the past year—the Nifty MNC Index has given a return of -6.21 per cent compared to the Nifty 50’s 13.11 per cent—these funds have sound long-term track records.  

One positive feature of thematic funds is that the MNCs included in their portfolios have strong, professional management, often with global experience. They observe global standards of corporate governance. Many MNCs are leaders in their sectors because of their strong brands and technology. “Their foreign parents usually have a steady pipeline of products that can be introduced into the Indian market at the opportune time,” says Mahesh Patil, chief investment officer-equity, Aditya Birla Sun Life Mutual Fund. MNCs also tend to be good at capital allocation. “They are focused on their businesses and don't diversify unnecessarily, as Indian promoters sometimes tend to do,” adds Patil. If they have a surplus, they pay a dividend, hence the dividend pay-out ratio of these stocks tends to be high. According to Anish Tawakley, fund manager, ICICI Prudential AMC, “MNCs generally have an edge over their peers due to their intellectual property and technological knowhow. These companies also have robust balance sheets and attractive financial return ratios.” 

MNC stocks tend to be less ivolatile, which makes the portfolios of these funds more stable. Due to the consistency of earnings of these stocks, MNC funds provide downside protection in a falling market.  

Investors need to be aware of the risks in these funds as well. Since this is a thematic category, you will not get the same degree of diversification as you would in a diversified-equity fund. Moreover, there are periods, lasting for more than a year, when these funds underperform the leading market benchmarks, such as the Nifty, significantly. “When the high-quality theme is playing out, these funds move up. But when the market is chasing growth, high-beta or cyclical stocks, they tend to underperform,” says Patil. They also take a backseat during a broad-based market rally led by mid- and small-caps. Also, after the valuations of MNC stocks have touched high levels, they could witness a time correction. 

The way the global parent treats its listed Indian subsidiary can also be a source of risk. There have been cases where the global parent set up another 100 per cent-owned, unlisted subsidiary in India, hindering the growth opportunity of the listed entity. According to Gautam Kalia, head of investment solutions, Sharekhan by BNP Paribas, “There is also the risk of buy-backs and delisting by parent companies.” He adds that investors should watch out for overlap with the portfolios of their other diversified-equity funds, especially large-cap funds.

Investors who bet on these funds with at least a five-year horizon are likely to enjoy sound risk-adjusted returns. Exposure to this theme should not exceed 5 per cent of your equity portfolio.

While the older MNC funds invest only in companies listed in India, ICICI Pru’s fund will invest 35 per cent of its portfolio in MNCs listed overseas. “The fund manager will have a wider range of MNCs to choose from. However, the returns of such a fund will be affected by exchange-rate fluctuations. And if the ongoing trade wars escalate, many MNCs listed overseas could take a hit,” says Mumbai-based financial planner Arnav Pandya.