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Going Global Makes Sense But…

International investing adds more diversification to portfolios. However, in India, existing regulations limit the advantages

Indian mutual funds offer a broad range of funds that provide diversification within Indian equities and bonds. But the current hiccups in both these markets have given rise to the question of whether diversification within one's own country is enough. While investors had no choice once upon a time, the availability of international investment options make it useful to examine this issue in detail.

Indian fund houses are increasingly recognising the usefulness of having international exposure in one's portfolio. Currently, in India, two mutual funds offer international investing opportunities.

On the equity side, we have Principal Global Opportunities Fund and on the debt side, there is Franklin India International Fund. If you look at these two funds' performances in recent times, you would be more than happy. For instance, in May 2004 when average equity fund lost 15 per cent, Principal Global Opportunities Fund gained 1.7 per cent. And the case is even stronger on the bond fund side. This year (in 2004), in five of the nine months, income funds have delivered negative returns, whereas, Franklin India International Fund has managed to give positive returns in seven out of nine months.

Recently, India's biggest fund house, UTI Mutual Fund has also filed an offer document with SEBI for the launch of an International fund called UTI-SSgA-Global Titans Index Fund. This fund would invest in securities of companies comprising the Dow Jones Global Titans 50 index. SSgA stands for State Street Global Advisors (SSgA) - the world's largest institutional asset manager. UTI has recently tied up with SSgA to act as an investment advisor to UTI AMC for overseas investments by its funds.

About Available Options
Principal Global Opportunities Fund invests in stocks of foreign companies. In its five-month stint, the fund has largely invested in basic/engineering and automobile stocks, together accounting for 36 per cent of its portfolio. And in terms of global diversification, 33 per cent of the fund's assets have been invested in US stocks, 30 per cent in Japanese stocks and 33 per cent in European company stocks as on September 30, 2004.

On the other hand, Franklin India International fund is a sub-fund, which invests in units of Franklin US Government Fund. It is a US mutual fund that manages $8.1 billion of assets under management.

This US fund invests exclusively in the mortgage-backed security that is backed by the full faith and credit of the US government.

The UTI-SSgA-Global Titans Index Fund as mentioned above will also invest in foreign company stocks but its investment universe will be limited to the stocks in the Dow Jones Global Titans 50 index. The Dow Jones Global Titans Index is a float-adjusted index containing 50 of the world's largest and best-known blue-chip companies like Microsoft, Nestle, Coca-Cola, etc. Apart from free-float market capitalisation, the index also takes into account the sales/revenue and net profit for each of the companies.

As on September 30, the Dow Jones Global Titans 50 index comprises of 29 stocks of US, eight of UK, four of Switzerland and seven stocks of other European countries. Unfortunately, only two Asian companies figure in the list - Toyota Motors (Japan) and Samsung Electronics (South Korea). In terms of sector exposure, the top three sectors as on September 30 were financial (21.46 per cent), healthcare (17.63 per cent) and energy (15.93 per cent).

International Dynamics
Though big events tend to affect stock markets globally, general trends in various markets vary. There is hardly any correlation between any of the foreign markets meaning that the stock and bond markets in India may not move in tandem with that of Europe, US or Japan over a long period of time. Thus, international diversification reduces overall volatility and risk of an investment.

As we have already seen in 2003, many of the equity markets in emerging countries in Asia including India gave stupendous returns. The BSE Sensex gained 73 per cent, Indonesia's Jakarta composite rose 62.8 per cent, Taiwan's Taiex gained 32.3 per cent and South Korea's Kospi put on 29.2 per cent. Interestingly, after plunging 73 per cent since 1989, Japan's Nikkei stock index jumped 17 per cent in 2003. In US, the Dow Jones Industrial Average also managed to gain 25.3 per cent.

But this year, the markets in Asia have not delivered any good returns. Same is true of US markets. While Dow is down 3.57 per cent, Sensex is down 4.37 per cent. However, you never know which market will turn its gear. So why should one deprive himself of the opportunity of investing in global markets?

The best example of benefit of international diversification has been witnessed in the bond side. Despite a series of rake hikes in the US, the US bond market has hardly felt the heat, whereas Indian debt markets have turned sour without any interest rate hikes. For instance, in the first three quarters of 2004, while Franklin US Government Securities Fund is up 2.81 per cent, the average income fund in India is just up 0.08 per cent.

The negatives of investing internationally include higher expenses, and operational issues (disclosure, accounting, etc). But investing through funds reduces this complication to a great extent. For instance, there is a cap on total expenses charged by a fund (2.5 per cent for equity funds and 2.25 per cent for debt funds).

Still, there is currency risk. The returns from international investing could be heavily influenced by currency movements and can result in higher volatility. While looking at a fund's past performance, currency effects should be differentiated from local returns. When the rupee is appreciating, returns from foreign investing will be reduced and vice versa.

Fortunately, in three months ending August 31, 2004, the rupee has depreciated nearly 2 per cent vis-à-vis US dollar. Hence, Franklin India International Fund has gained 4.52 per cent (adjusted in rupee term) against Franklin US Government Securities Fund's gain of 3 per cent. But in September 2004, the rupee has appreciated by nearly a per cent, thus affecting Franklin India International Fund's return. Therefore, international exposure should be confined to small percentage of an investor's total investments.

On the plus side, the rupee denomination of these schemes gives you virtually unlimited exposure to foreign securities. The US dollars 25,000 that the RBI has allowed individuals to invest abroad remains untouched. Thus, the overall amount which can be invested abroad increases.

Why Do We Have Limited Fund Options?
First and foremost is the lack of international expertise. Only those fund houses can launch such funds, who have some experience in managing global funds. While Principal and Franklin Templeton have their international parents, UTI has tied up with the State Street Global Advisors (SSgA), the world's largest institutional asset manager.

Then there are two SEBI regulations for international investing (SEBI circular no SEBI/ MFD/CIR/6855/-2003 dated April 4, 2003), which is supposedly playing a barrier for the launch of more such funds. These are: First, Indian equity mutual funds can only invest in those foreign companies, which are listed and have a 10 per cent holding in a listed Indian company. This shrinks the whole investment universe to a great extent. And any change in the holding pattern of a company makes the fund vulnerable, as the fund manager has to quickly move out of that stock irrespective of the earnings outlook.

Though Principal Global Opportunities Fund has already been launched and is doing fine, there are some issues with regards to the UTI-SSgA-Global Titans Index Fund. Several companies in the Dow Jones Global Titans Index do not qualify this regulation. "To overcome this regulatory issue, UTI has suggested the regulator to allow using a reputed index in addition to the current set of guidelines. Should that happen, UTI would run the portfolio exactly as any other Index Fund would," said Ashutosh Bishnoi, Chief Marketing Officer, UTI Mutual Fund.

Second, the maximum limit for investment by mutual funds in overseas capital and debt markets is fixed as per the SEBI guidelines. As of now, this limit is 10 per cent of net assets of each mutual fund as on January-end of the current year subject to a ceiling of US $ 50 million (equivalent to Rs 225 crore).

Our Take
Unless these rules are relaxed, scope for international funds will be limited. Though India is slowly progressing towards full capital account convertibility, but the regulating body will have to take some smart steps to make foreign investment more attractive and favourable. With increasing globalisation, it now makes more sense to invest overseas. Even Indian companies are going out through partnership and acquisition of foreign companies. Why we, as an investor, get deprived of exploring this opportunity?

Remember that having exposure to international markets increases your opportunity to make gains, and at the same time reduces your risk in a given market. However, international investing only helps if this is done in addition to the domestic investing and international exposure should be confined to small percentage of an investor's total investments.