In the mutual fund industry NFOs (new fund offer) for global funds are the latest trend and they are fast catching the investor’s fancy. Several fund houses have already launched their global fund offerings; we understand that there are many more in the pipeline.

As the name suggests, global funds invest in global stocks and/or mutual funds (that in turn invest in global markets). So what do global funds offer to Indian investors?

New opportunities

Global funds have opened a window to international asset markets for Indian investors. They have made it easier for Indian investors to diversify their portfolios (and in this way de-risk them) beyond the conventional domestic equity and debt avenues.

For example, through a global fund one can now participate in the rising fortunes of IBM, Intel, Microsoft or Google as oppose to sharing the upside in Wipro, Tata Steel or Bharti Tele, through a domestic equity fund.

Investing in global funds can also prove advantageous if you have a future liability in that currency/country. For instance, if you plan to send your child to the US for higher studies, investing in an US fund can be an option for you.

By doing so you would have done away with the currency risk (explained later in this article). But investing in global funds has its fair share of risks, which investors must understand. Here is a checklist for you.

Factoring the expenses: Investors in mutual funds incur expenses at two levels. The first is a one-time expense (in the form of an entry/exit load) and the other is the recurring expense related to fund management expenses, market and sales expenses, administration expenses to cite a few.

The recurring expenses are always passed on to investors. If you never realised this fact, it is because the daily NAV (net asset value) that is declared factors in the expenses.

It is equally important to evaluate a global fund from the ‘expense’ perspective. This is more so since many of the global funds that are being launched have opted for the FoF (fund of funds) route as opposed to direct investments in global markets.

While FoFs add the diversification edge to your portfolio, this comes at a cost. FoFs have a double-layered expense structure. So all expenses (one-time as well as recurring) are incurred twice in an FoF; first for the FoF itself and second for the underlying scheme. Although the underlying schemes often waive off the entry load, the recurring expenses continue.

The reason why investors have to be very concerned about the expenses incurred by their mutual fund investments is because over a period of time, higher expenses can and will erode returns significantly.

Don’t ignore currency risk: Currency risk is one of the more vital factors associated with global investing. Let’s understand this risk with the help of an illustration. Suppose you invest Rs 4,000 in a US dollar fund.

The Rs 4,000 will be converted into US$ 100 (approximating, for convenience). This US$ 100 is then invested over a one year period; now assume you earned 10 per cent return i.e. the value of your investment is now US$ 110.

But what is the value in terms of Indian Rupees? Let’s again assume, that the India Rupee actually appreciates vis-à-vis the US dollar and touches Rs 36 per US dollar in a year.

So, effectively, the US$ 110 translates to Rs 3,960.So, even though in dollar terms you earned 10 per cent, in Indian Rupee terms you actually lost 1 per cent. This is just a hypothetical example to illustrate currency risk. Conversely, if the Rupee depreciates your gains could actually be magnified.

In our view, investors can take this risk under certain circumstances; for instance if you plan to send your child abroad for higher studies, then you can consider investing in a global fund domiciled in the country where your child will be studying.

Then there is country/market segment risk: Another type of risk related to the currency risk is the country/market segment risk. There is no doubt that by investing in global funds, investors get an opportunity to diversify their portfolio across countries, but the same also amounts to taking on country/market segment risk.

For instance, if a global fund invests in a particular country (say the US) or a market segment (emerging markets), then its investors are exposed to the negatives and positives of that economy (over here the US) or that market segment (over here emerging markets).

It is best to select a well-managed fund that can invest across global markets. Its fund management team will get the much-needed flexibility while deciding where to invest.

Check the track record of the underlying investments: Through global funds Indian investors are venturing into an investment universe to which they have had little or no exposure.

Hence, it is advisable for investors to check the track record of the underlying investments of global funds (particularly in a FoF global fund), before investing in them.

We recommend that investors evaluate the underlying investments based on a rating wherever available (try Morningstar or Standard & Poor ratings, for instance).

Ensure that you have an adequate investment time frame: We believe that investments in equities and related assets should be made with at least a 3-5 year investment time frame. In an open-ended global fund this should not be a problem because you stay invested for as long as required.

But in a close-ended global fund you should consider funds that have an investment tenure of a minimum of 3 years and if it is lower than that, then it is best to avoid such funds. For equity investments, longer the tenure, the better it is in our view.

Is it diversified adequately and appropriately? Investors are meant to get the benefit of diversification by investing in global funds; hence it is surprising when global funds deprive investors of this benefit.

Many of the global funds that have been launched, and going to be launched, are investing predominantly in emerging markets, which to an Indian investor is not particularly exciting because India by itself is an important emerging market.

An Indian investor ideally would like to diversify by investing in other markets like US or Germany, which behave differently from emerging markets. So go for global funds that invest across market segments.

At the other end of the spectrum are global funds that diversify excessively. Sundaram Global Advantage Fund, for example, invests across four asset classes: emerging market equities, real estate, commodities and domestic fixed income. In our view, investing in a scheme that aims to diversify across so many assets may not be easy to fit in a portfolio.

Ensure that your India Portfolio is in place: While we welcome global funds and believe that investors should invest in them to diversify their portfolios, we insist that they also have an India portfolio consisting of well-managed funds with established track records. Put simply, global funds must not be considered as a stand-alone investment, rather they must form a part of a portfolio.

How much to invest in global funds? If its for the purpose of diversification and asset allocation, investment in global funds should not form a large chunk of one’s portfolio. Typically, such funds should account for a smaller portion of your portfolio, may be around 10 per cent.

Don’t rush into investing in global funds: Like with investments in domestic funds, putting money in global funds need to be evaluated thoroughly after drawing comparisons with comparable offerings.

So avoid the urge to rush into investing in a global fund and do not get carried away by media hype, distributor’s persuasion or tall claims.

Evaluate them across all important parameters by comparing with other global funds of similar nature. Don’t rush thinking you will miss the bus, there are many more global funds in the pipeline.

Source: Personalfn, a financial planning initiative. For   information email: info@personalfn.com