Internationally Unsuitable

Whenever the rupee weakens, the thoughts of mutual fund investors start drifting towards international funds. Right now, if you were to spend a few minutes rooting around the research tools available on Value Research Online, you would find it hard to ignore international funds. Currently, there are a set of international funds whose returns over the last month are up around 8 to 10 per cent. The top performing fund is Motilal Oswal Mutual Fund’s MoST NASDAQ-100 ETF, which is an index fund based on the NASDAQ and has gained 16 per cent over a month. This at a time when most normal Indian mutual funds are languishing with returns of 3 to 5 per cent over the same period.

However, even if you take one short step beyond the obvious, you’ll realise that the magic of international funds is actually the magic of exchange rates. The returns that you see in these funds is a product of the actual investment gains and losses and the exchange rate changes between the currency of the underlying investments and the Indian rupee. Naturally, at a time like the present, when the rupee seems to be nose-diving daily against the dollar, funds that invest in US stocks are showing extraordinary gains. The arithmetic is straightforward. Even if the dollar value of the foreign investments of such a fund stay static, each dollar will be worth more in rupees.

To take the example of MoST NASDAQ-100 fund mentioned above, the NASDAQ index itself is up by 5.28 per cent over a month as I’m writing this. Multiply that by the fall of the rupee and there are your gains. However, this is not the point of international funds at all. In fact, this is the most dangerous source of returns in a fund. Every time investors notice international funds making extraordinary returns because of forex movements, it should actually serve to frighten them about the extraordinary gains that are the other side of the coin.

Conventionally, the main reason that an investor should look abroad is to diversify geographically. When investments in one part of the world are not doing well, then those in another part may be doing well, thus shielding investors, or vice versa. However, geographical diversification as a defensive strategy ended during the global financial crisis of 2008. With all economies linked, the carnage was universal and having a little more in one market than the other wouldn’t have saved you much money.

However, most of the international funds that are offered to Indian investors—24 out of 28 at last count—are some sort of novelty or narrowly-focussed funds. They are focussed on some theme like gold or oil or real estate or on some particular region like China or Latin America or on both in combination. Thus these funds have very narrow investment mandates. Either they are thematic funds or region focussed. This means that they are of no use at all when it comes to offering general diversification. Investing in such funds implies that investors need to judge for themselves which regions or which sectors or which themes will do well. However, not having to make such decisions is exactly the convenience that mutual funds are supposed to deliver—this is in fact the core service that mutual funds are supposed to deliver.

Extending this logic to its natural conclusion, even the choice of whether one should invest in an international fund should be made by the fund manager. As a fund investor, your job should be limited to choosing a handful of diversified funds, everything else should be off-loaded to the chosen funds' managers, including worrying about foreign exchange rates. Ideally, one would like to see international funds disappear as a category. The mandate of all diversified Indian funds should be amended to allow the fund manager to consider the entire global economy as his investable universe. Unfortunately, the kind of international funds that are largely available in India are not suitable for such a purpose.