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Breaking the Currency Barrier

Franklin Templeton Investments' income fund invests exclusively in US government securities. With interest rates being higher in India, does it make sense to invest abroad now? Read ahead to find out the pros and cons of investing abroad.

Franklin Templeton Investments has introduced a unique income fund that will invest in US government securities. Known as Franklin India International Fund, this scheme will give investors access to a portfolio of US government securities by investing in the Franklin US Government Fund, which is a gilt fund run by the AMC's US-based parent. This will be the second such fund in India. Sun F&C Mutual was the first to launch an International Plan as part of its Fixed Income Securities Fund in May 2002.

Considering the fact that gilt funds have been going great guns in India, why should one invest in a US fund? Especially when the yield on the 10-year paper in India is 6.34 per cent and that of the equivalent US paper is 4.26 per cent, as on November 28, 2002. On top of this, there will be currency risk also. One answer could be to hedge future dollar expenses against a rupee fall. Another possible benefit is that investors get to diversify across currencies and stabilise returns as countries go through different economic cycles.

But on the downside, the fund is likely to have a small size compared to the market due to government limits on overseas investments. These restrictions could result into higher transactional expenses and poor economies of scale for this fund. The fund is also exposed to external risks such as currency risk and downgrade risk of US Government debt.

While funds have been venturing overseas the Securities and Exchange Board of India (SEBI) has increased the investment cap on foreign debt paper to a maximum of 10 per cent of the assets under management. This limit was earlier four per cent. The changed limit, however, continues to be subject to the earlier guideline of a minimum investment value of $5 million and a maximum of $50 million, irrespective of the size of the AMC. In effect this means that funds having a corpus of $500 million can now invest up to $50 million in place of the earlier $20 million. However, the total foreign investments cap for all Indian funds together stays at $500 million. Franklin Templeton AMC manages Rs 8,494 crore, as on October 31, 2002. This translates into $1,762 million. So the AMC does not gain from this change in the regulations. Based on the current limit of $50 million, the maximum amount that this scheme can rake up is Rs 241 crore. And this seems a long way to go if one sees the Rs 6.72 crore that Sun F&C International Plan managed to collect.

The scheme is an open-ended one with a minimum investment of Rs 25,000 during the IPO and Rs 1,00,000 after this. There is no entry or exit load during the IPO but a load will be applicable post-IPO. The fund aims to invest 80 to 100 per cent of the portfolio in the US Fund. The rest would be invested in money market instruments to maintain liquidity and in the rupee forward market to hedge currency risk.

From an investment viewpoint, the key issue is returns. A review of the US Government Securities Fund reveals a 10, five- and three-year annualised return of 5.4, 6 and 7.5 per cent, respectively. If we consider the rupee depreciation, the effective return works out to 9.1, 10.8 and 11 per cent, respectively. This is not a bad bet at all. However, if the rupee appreciates, it will eat up the fund's return.