Over the last couple of years, there has been a notable increase in the number of mutual funds that are offering international investing as part of their objectives. However, as the number of international funds has increased, investors should note that they can no longer be relied upon to deliver what should have been their basic utility-protection through geographical diversification.
To understand why this is so, and what international funds actually mean for your portfolio, let's review the history and the basic logic of such investments. Investing abroad was first permitted six years ago. Some time after that, the first international equity funds were launched, the first one being the Principal Global Opportunities, which was launched in 2004. At the time, everyone took the logic of international investing to be that of straightforward geographical diversification.
If the stock markets of one region of the world did badly, then having some money in another region would offer some protection. Of course, international funds evoked very little response in those days. Through that entire period, the Indian stock markets offered some of the highest returns in the world and there was no way that Indian investors would be attracted to putting money into markets that were underperforming India.
In any case, you can surely guess how the story of geographical diversification as a defensive strategy ended. Came the global financial crisis of 2008 and it was clear that such theories weren't worth the paper they were written on. The whole world crashed and having a little more in one market than the other wouldn't have saved you much money. This is the flip-side of globalisation. If businesses around the world can share the spoils of global growth, then they must also pay a shared price for a global slump.
So is geographical diversification dead? Despite apparent evidence to the contrary, I wouldn't say so. There's no doubt that geographical diversification won't save your money from a deep worldwide crisis like that of 2008. However, that's a superficial analysis. Nothing would have been immune to that kind of carnage, but it would be wrong to take that crisis as a lesson for normal times. It's clear that different regions of the world are going to have very different growth rates. Even though the global economy is interlinked, the fate of say a Japanese company whose business is mostly domestic and that of an Indian telco which is expanding aggressively into Africa would be very different.
Over the long-term, these kinds of differences could well build up into substantial differential gains. Which is why I think that geographical diversification as a short-term defensive strategy may be meaningless but is still relevant as a long-term growth strategy.
The kind of international funds that are largely available in India now are somewhat, but not completely suitable for such purpose. On the one hand, most of them are not pure foreign funds. This is a side-effect of the tax laws of the country-only funds with more than 65 per cent exposure to domestic funds are taxed like equity funds. So to enable investors to enjoy zero long-term capital gains, funds have to run like balanced Indian-foreign funds. This is good as it should give fund managers the option of feeding profits across market cycles, just like asset-type rebalancing does.
On the other hand, far too many of such funds are thematic funds. There are international commodity funds, oil funds, gold funds and whatnot. These are complicated products that require investors to be knowledgeable enough to take a call on some particular theme or sector in some geography. Ideally, you should be able to choose between completely diversified funds, which could be in any sector or theme anywhere in the world. Failing which, a fund that balances India with a region like China could do the trick.
All things said and done, investing abroad definitely has its uses. However, protecting you from worldwide crisis is not one of them.
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