Should you invest in international funds? Take exposure to developed mkts

Reduce home-country risk with international funds and give the portfolio a dash of diversification

With a return of 6.88 per cent, international funds have been the best-performing category among mutual funds over the past three months, according to data from Value Research. The average return over the past one year has also been high at 16 per cent. A high level of liquidity internationally, low-interest rates in the developed world and the on-going global economic recovery have contributed to the robust performance of equities globally.

With valuations in the Indian markets at high levels and earnings recovery getting delayed, investors should diversify their portfolios by investing in international funds.

An investor can mitigate home-country risk by taking exposure to international markets. Portfolios that are focused entirely on the home country are hit hard when the home market underperforms. Also, India belongs to the emerging market (EM) basket. There are years when EMs do well and developed markets do poorly, and vice versa.

Source: Ace MF

By diversifying into developed market equities, Indian investors can mitigate the impact of this cyclicality in returns. Having exposure to international funds also allows Indian investors to reduce currency risk. Increasingly, many Indians will have goals, such as foreign education and travel, which are denominated in foreign currencies. By owing foreign assets, they can reduce the risk of the rupee depreciating against major currencies such as the dollar over the long term.

Before venturing abroad, take adequate exposure to the home market. "The investor should first have exposure to both Indian equities and debt and only then venture into international funds. Only a small portion of his equity portfolio should be invested in these funds," says Rajat Jain, chief investment officer, Principal PNB Asset Mutual Fund. For beginners, it should be 10 per cent of equity portfolio. Exposure can be raised over time to 20 per cent.    

The international category has a wide variety of funds which can be confusing: Country and continent-specific, commodity-focused, and so on. First-time investors should avoid commodity-focused funds, which carry a high degree of cyclical risk. Their first fund should be one that gives them exposure to developed markets. "Since India belongs to the emerging market pack, it is likely to have higher correlation with other emerging markets.

To get the benefit of diversification, Indian investors should take exposure to a developed market fund," says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisor. This can be done by investing either in a diversified global fund that has high exposure to developed markets, or by investing in a US-focused fund. "Investors can invest in a diversified global fund, but many of them currently have very small assets under management (AUM).

Hence, opt for a US fund with a reasonable AUM," says Dhawan. (Funds with very small AUMs face the risk of closure.)The US is the world's largest equity market and accounts for a high share of global equity market cap. Many of the stocks that US-focused funds invest in are multinationals that earn their revenue from across the globe. Hence, investors can get both developed-market exposure and global diversification by investing in these funds. 

When choosing a US-focused fund, look at some of the same parameters in the mother fund (in case of a fund-of fund) that you would in a domestic fund: Performance track record, expense ratio, fund manager's track record, and so on. Go for a fund with a diversified rather than narrow mandate (such as just technology). 

When choosing an international fund, be mindful of currency risk. It is quite possible that you may invest in a geography where the market does well but the currency depreciates, thereby eroding your fund's return. Finally, remember that your international fund will be taxed like debt funds.