I remember a query by a reader in an Indian financial daily – should he consider investment in an overseas fund for diversification? The reply from the financial guru was – no need as there were plenty of opportunities in the Indian equity market and only if he has exhausted the investment avenues in India, need he to look abroad.

It is true that Indians are underinvested in the domestic equity market, let alone investing in overseas equities.  Has anything changed since now and then? Plenty ! A look into the summary of the Credit Suisse Global Investment Returns Yearbook 2019 gives a better perspective.

From the above pie chart, in the beginning of the 20th century, the UK equity market was the largest in the world, accounting for a market cap of 25%, followed by USA at 15%, Germany 13%, followed by France, Russia and others.

By the end of 2018, the equity market in USA contributes 53.3% of the world’s market cap., while the rest of the world follow in single digits; Japan at 8.4% and UK at 5.5%. Notable though is the emergence of China at 3.4%, higher that France and Germany. And India is yet to contribute a significant number (included from 1953, as per the report).

In addition to the change in the composition of the contributing countries in the equity landscape, the composition of the contributing industries have also undergone a massive change. In US, in the 20th century, the railroad was the dominant industry, while in the 21st century, its technology. 

Popularly called the FAANG companies – Facebook, Amazon, Apple, Netflix and Google; all of them claim India to be their most important market after US. Diwali in India is eagerly awaited in US; the festivities and purchases during the season are set to ring the cash registers in US. Shouldn’t the Indian investors in turn benefit from the increase in the revenues and market cap. of these companies? 

To list out the reasons for investing in an overseas fund:

[1] US has a strong clutch of world’s leading and fastest growing technology companies lacking in India and investors should consider investing in these companies.

[2] Investment in US equity can be a hedge against the depreciating rupee. “Over the long run most currencies weakened against the US dollar, and only a couple (for example, the Swiss franc) proved perceptibly stronger than the US dollar.” Press Release from Credit Suisse Global Investment Returns Yearbook 2019

[3] Overseas investment can provide a geographical diversification to an equity portfolio as the markets – classified as developed (DM), emerging(EM), frontier(FM) – they don’t move in tandem.

The new crop of fintech companies in India have made investing in mutual funds paperless and convenient from the comfort of home. While people are lapping up the new DIY era of mutual fund investing, the funds that constitute a portfolio have not seen much of a change. Depending on the investment horizon the normal composition include a large cap, a mid cap, a muliti cap, a balanced advantage and maybe a debt fund. But the idea of diversifying with an overseas fund is not considered necessary. In fact the overseas funds are not even rated in India simply due to the lack of interest in them.

The easiest way to achieve the overseas equity exposure is the mutual fund route. If we can have international vacation photos on Facebook and shouldn’t an overseas fund figure among their mutual fund investments? Just like investment in gold a 10% exposure could be a start.

But where would an overseas fund fit in the mutual fund portfolio? The mutual fund investor has four main investment goals – buy a home, child’s education, child’s marriage and retirement.

While saving for the child’s marriage, Indian families save for gold – either buy physical gold or ETF or Digigold or a savings scheme with the local jeweller, in addition to the mutual fund investments; fully aware of the inflation in gold prices and the need to be prepared. Accordingly, the overseas fund can be considered in the child’s education portfolio, esp. if he or she is planning on getting a degree abroad. The currency diversification that an overseas fund investing in US provides can boost the overall returns esp. against a depreciating rupee.

The AUM of the handful of international funds available currently is miniscule compared to the AUM of the Indian equity funds. And among them there are few good funds worth considering and their returns have also been good – ICICI Prudential US Bluechip Equity Fund, Franklin India Feeder Franklin US Opportunities Fund, Motilal Oswal Nasdaq 100 ETF – these form three classes of fund – actively managed fund, feeder fund and ETF respectively.

US is not the only country of focus; another could be our immediate neighbour China. As an example the feeder fund Edelweiss Greater China Equity Off-Shore Fund comes to mind. “Just as developed markets are dominated by the huge US equity market, China is far the largest EM. Its weight in the EM indexes has grown rapidly from just 3% in the early 2000s to 30% today. By the end of 2018, Chinese equities had an aggregate full-cap value of some USD 10 trillion. The negative factors that have contributed to the Chinese market’s past poor performance are set to be reversed, as China continues to open up and reform its financial system including the expansion of A-share inclusion into leading index series.” Press Release from Credit Suisse Global Investment Returns Yearbook 2019

The Chinese counterpart to the FANG companies are the BAT – Baidu, Alibaba and Tencent. But these companies are listed and traded outside of Mainland China. 

To conclude,  the investments overseas funds are treated as debt in India; for equity fund classification, it is mandatory to have a majority holding in Indian equity. Even though they are meant only to occupy a 10% allocation in the portfolio; the retail investors will be less aware of the overseas market as compared to domestic market and hence the necessary caution and education on the risks is advisable. As with all mutual funds, its a long term investment; to accomplish the diversification strategy you are required to select only one fund; but choosing the wrong market can have adverse impact on the overall returns. Do the homework !!

Till next post, take care !!