With the rupee falling, especially against the US dollar, many investors may be contemplating on investing in international mutual funds. However, is it a good idea?
With the Indian rupee falling, especially against the US dollar, many investors may be contemplating on investing in international mutual funds. However, before doing so, one should have a clear understanding of what international funds are, what should be the rationale for investing in such funds and what are the associated risks.
As the name suggests, an international fund/overseas fund invests in the international markets. Investments of these funds can be either in equity or debt or in other asset classes such as commodities, real estate, among others. In addition to creating opportunity to invest globally, these funds help individuals achieve geographical diversification and at times serve as a hedge against the falling domestic currency. Investments in international funds are worthwhile especially if the domestic economy is facing long spells of economic deflation and there is a dearth of overall investment opportunities.
There are no clear-cut categories of international funds. However, they can be differentiated by investment features. For example, some funds are country-specific international funds while some are commodity-based international funds which invest in specific commodities. Similarly, there are thematic funds which have specific criteria for investment asset class such as energy, agriculture, consumption, real-estate etc. Below are some of the international funds along with their historical returns.
It is also important to point out some of the risks associated with investments in international funds; by investing in international funds one exposes one’s investments to both currency and geo-political risk.
Among others, the most important risk associated with international funds is the currency risk. Since the investments made by the AMC in a foreign country is made in the foreign currency in addition to the risk associated with investments in various asset classes, one gets exposed to currency exchange risk. For example, in the current context, the Indian rupee has depreciated approximately 12% against the US dollar. The depreciation in the rupee actually helps improve the returns of international funds focused in the US markets. Currency risk, however, is a double-edged sword because the depreciation of the local currency against the foreign currency improves the returns on the investment. However, the appreciation of the local currency reduces the returns. Indian rupee has appreciated against all major currencies except the dollar. So, if we leave the US-focused funds, an average investor would receive negative returns due to currency movements in other regions of the world.
In addition to the risks associated with currency movements, international funds expose one’s investments to geo-political risk, which is country-specific, and beyond the control of anyone. For examle, in the current geo-political environment, countries such as Turkey, China, Russia, Iran, Canada, Mexico are going through a lot of economic upheaval due to the nature of their trade with the US. International funds, which are focused on these countries, would therefore be exposed to these risks, which would in turn affect their returns.
Should You Invest Now?
In the current trend of the Indian rupee’s de-valuation against the US dollar, the most obvious question concerning the investor fraternity could be that, is it the right time to benefit from investing in international funds? For analysis purposes, following is the trend of the Indian rupee against the US dollar in the past one year.
RUPEE VS US DOLLAR ONE-YEAR CHART:
It can be seen from the chart that the rupee has already depreciated around 11.69% YTD against the US dollar in 2018. The depreciating rupee has a positive impact on the NAVs of international funds that invest in the US or use the US dollar as the investment currency. We believe that at this point initiating fresh investments in international funds solely based on the depreciation of the rupee against the US dollar is not advisable as there has been a significant decline in the rupee already, and there is a limited room for further decline as we would witness fierce defense of the rupee both by the RBI and by the Indian government if the rupee slides below 73 against the US dollar. Moreover, we believe that investment in these schemes should be based on the idea of geographical diversification and for growth opportunities with the acknowledgment that these investments would carry both currency risk and geopolitical risks.
Finally, it should be emphasized that tracking currency movements and making a prediction on currency direction is not an easy task as it involves analysis of several factors and needs tools and data, which are usually not available to an average investor. International funds are good investment tools for diversification purposes and if there is an overall lack of investment opportunities in one’s domestic country. In the Indian context, we believe that there are ample opportunities across sectors to generate decent returns. Therefore, making investment in international funds solely on the basis of achieving diversification is advisable whereas investing in these funds just because the rupee has depreciated does not carry a lot of weight, at least at this point of time where the rupee has already depreciated significantly.