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International funds should be a routine choice

No equity fund investors should ignore international funds

International funds should be a routine choice

One must admit that apart from the financial logic of investing some of one's money in foreign stocks, the glamour of seeing names like Alphabet, Amazon, Apple, Netflix, etc., plays a role in persuading people to allocate some money to international investing. However, that's obviously not the right way to invest. The investing case for choosing one or the other international fund must be examined just as it is done for any domestic investments.

The recent launch of a fund named NYSE FANG+ brings a new level of this brand awareness to investors. The fund, which is from Mirae Asset, is an ETF which is based on a highly concentrated index which has only 10 of the biggest name tech stocks in the world, namely Alibaba, Facebook, Alphabet, Apple, Baidu, Nvidia, Amazon, Netflix, Twitter and Tesla. Based on recent past performance, this would be a great fund to invest in. However, as we all know very well, past performance is not everything. Not just that, a fund with a small, fixed portfolio of such names is an unusual entity for any Indian investor, something that we must try and understand.

Historically, there have been few types of mutual funds that are simultaneously so useful as well as so ignored by Indian investors as international funds. The advantage of international diversification, coupled with the cushion of the continuous exchange rate advantage that the rupee's depreciation offers, makes foreign funds a no-brainer. For many years, the higher taxation on foreign equity investments was a problem. Returns from equity funds in India were zero tax but this exemption was available only to funds that invest in domestic equity. Returns from international equity funds were, at best, subject to 20 per cent tax after indexation. This gap has now closed because domestic equity fund returns are now taxable at 10 per cent without indexation. That means that practically speaking, the tax disadvantage is gone. In fact, depending on the indexation, there will be many situations where you may pay less effective tax on foreign equity.

Which brings us to choosing funds. While there are a large number - almost 50 - of international funds available from Indian fund companies, relatively few are diversified funds that invest in major businesses. In fact, more than half are relatively exotic funds that have some regional or industry theme. For the average Indian investor who just needs a certain amount of global diversification, such funds make little sense. It's far better to find a globally diversified fund or a US-based fund that invests in the major industries and business of the world.

Moreover, given the need for low cost and low research-effort, US-based passive funds make the most sense. Unfortunately, that too does not narrow down the field enough. As is true of almost any kind of investment, there's a trade off between performance, volatility and diversification. If you go to the 'Equity: International Funds' section of Value Research Online and start looking at the returns and the names of various types of funds that invest in the US, you will notice that a fund based on broad indexes like the S&P 500 has performed well, but something based on the NASDAQ 100 has performed better. Although the FANG+ is a new idea here, these stocks have performed even better. Concentration into recent top performers always looks attractive while the going is good.

For Indian fund investors looking to invest abroad, this is a tricky question to tackle and indeed, the answer is not easy. It is essentially a personal call on risk and returns. The exchange rate advantage makes it slightly easier as it acts as a (small) cushion but you could use it either way.

Regardless of the path you choose, and the added workload of an entirely new kind of fund, investors should not ignore international funds. There was a time, more than a decade ago, when the Indian markets were always so much better than international ones that one could have argued against any international investing whatsoever. Those times are gone. Whether it's an opinionated strategy like FANG+ or something more sedate, international funds should not be ignored by anyone.