Should You Invest In International Funds In 2018?
International funds allow investors to diversify their portfolio outside the country, but these funds too suffer from valuation risks
International funds have given their domestic counterparts a run for their money in 2017. As of 10 December, Top 5 performing funds in the category have clocked an impressive 27.9 per cent one-year return, on average. As we move into 2018, the question on the minds of many mutual fund investors is — do these funds still warrant a place in their portfolios in the new year; either as a tactical play, or as a hedge to their domestic holdings?
International Funds 101
International funds typically invest outside of domestic markets, in full or in part, through a mechanism known as ‘feeder’; wherein moneys are pooled locally and invested into an offshore mutual fund operated by the same global asset management company. For instance, Principal Global Opportunities Fund, a locally managed international mutual fund, deploys all of its assets into Principal Global Investors Emerging Market Equity, a fund that predominantly invests into Greater China and the Latin Americas. Pure international funds are not accorded the same tax efficiency as domestic funds, as they are treated as ‘non-equity’ from a taxation standpoint and hence attract the same tax rates as do debt-oriented funds.
Quite a few of India’s leading investment advisors have begun recommending international funds at this stage, particularly to their savvier clientele. Among them is Vivek Agarwal, co-founder of Upwardly.in, who believes that these funds “allow investors to benefit from growth stories outside the country, and also help them to diversify risks”
The “Past Returns” Trap
While there is a veritable overload of information available to investors related to how domestic markets are expected to play out, analysable data related to the dynamics of a particular international fund can be a lot opaquer. This often snares new investors into the trap of making investments based upon recent outperformance, which is akin to buying into an asset cycle at or near an interim peak.
Many international funds have been notorious for alluring investors based on short-term returns, only to disappoint them heavily later. A classic case in point is DSP BlackRock World Gold Fund, which churned out a mind-bending 148 per cent return between October 2008 and October 2009, only to then deliver an astonishingly poor seven-year annualised return of -7.32 per cent between 2010 and 2017!
The risks of an international fund are two-pronged in nature. Besides the more obvious risk related to the vicissitudes of the stockmarket of the country or countries related to the fund in question, investors would also be impacted if the currencies of the country bucket begin to sink. For this reason, Agarwal cautions investors to be “mindful of currency risks, especially while investing into country specific funds such as China or Brazil focused ones.”
Hedge Against Risks
The Nifty has soared nearly 25 per cent in the past 12 months, and valuations have collaterally grown rich. Of late, the index has been trading between 25 and 27 times current earnings, signalling at least a minor degree of discomfort regarding the medium-term sustainability of the current liquidity-fuelled rally, which will certainly require the booster shot of visible earnings growth to gather sustainable momentum.
Sarvesh Gupta, founder of Maximal Capital, is another one in the growing tribe of experts who believe in the utility of international funds — but mainly as a hedge to local risks right now. “At this stage, it is important for investors to have some portion of their wealth allocated to international assets, as that hedges them from an extreme case India specific negative risk,” he says.
POA for 2018
Despite their encouraging run in 2017, international funds are unlikely to be your portfolio’s proverbial “silver bullet” for 2018. Global markets have collectively received a tidal wave of liquidity in recent months leading to stretched valuations. Despite his exuberance about international funds as a category, Gupta advises caution too. “All global assets are looking very expensive. US equities are at record highs, while yields are still low and can increase with Fed rate hikes. So, there is a valuation risk in both international equities and bonds,” he says.
What should your play for 2018 be, then? First, steer clear of or book profits in emerging market funds that allocate moneys to high risk emerging markets such as Brazil, China or other LatAm countries. Stick with the big guns; namely, the US and Japan which, despite their high valuations, may be more favourable from a risk-reward standpoint at this point. You could even consider investing into a low-cost ETF such as Motilal Oswal’s MOSt Shares Nasdaq-100 ETF, which eliminates fund manager risk from the mix. Consider staggering your investments into your target fund using SIPs or STPs instead of heedlessly overcommitting lump sums. Finally, capping your overall allocation to international funds at 10-15 per cent is a good idea at this point.