The Mutual Fund Show: Investing In Foreign Funds Helps To Diversify, But It Comes With A Rider 

Roopa Venkatkrishnan: If you look at the mutual fund industry since 2003, I don’t think the opportunities were available in the initial periods of time. I think by 2006-07, opportunities were too less. But I think somewhere as the market evolved and the number of people started investing more, portfolios became huge for them and it became a diversification process. Then, at that point of time, if a large investor was there, I think allocations of 5-10 percent started because different types of funds started coming in. So you had the DSP Goal Fund, the DSP Oil & Natural Resources Fund and then you had funds such as Templeton that came with their U.S. equity funds. This is when opportunities starting coming in. JPMorgan came with the China fund. As the opportunities increased, portfolios diversified as much as you diversify into large, mid, and small cap in the Indian markets. It is a diversification which happens across the board and I think 5-10 percent in your portfolio will add and cushion the returns.

Jay Kothari: Yeah sure, but just to highlight the point that like many other markets, whether it is the U.S. or China, India tends to be slightly more home biased so we feel that India is one of the best markets and of course, we subscribe to that. But we also recognise the importance of other markets—diversifications; for example, electric vehicles.

Aspirational Indians love to use iPhones, but can you take advantage of that stock in your market? Probably not. So, these are the opportunities that you have externally. But let me just give you an interesting statistic. Of our Rs 12-and-a half crores of equities in India, into mutual funds, only Rs 2,000 crore worth of equities are offshore, or virtually zero percent. 99.8 percent is invested in India and a minuscule percent is invested offshore. So, there is a huge opportunity (with risks) which you have to be cognizant of. But is there an opportunity? I feel there is.

Kothari: Yeah, absolutely. Let me give you an example. As I mentioned, Indian companies have been going through a lull and there has been a demand slowdown. Let’s take the U.S. flexible equity. It’s from our stable. If you had invested in that form of strategy over a couple of years, that would have been a good decision. The U.S. markets continue to do well. The reason is they have stocks like Microsoft, Google, Amazon or the likes of these. Let me give you one more statistic, if you look at subsidiaries of American companies in India, whether it’s Amazon or Google, or whether it is Microsoft for that matter, these are growing anywhere between 100 percent and 50-60 percent, depending on the companies you are speaking about. When you compare it to our companies over the last five years, they haven’t been able to do that well.

So, at a point in time, when your home country and your companies are unable to really able to show that growth, can you go outside and take that advantage? Of course, you can. Similar kinds of opportunities exist with gold, which has had a good rally this year. It’s up 10 percent. So how do you take advantage of that? Are there enough listed equities within your country? Maybe not. It’s not. You have to look outside and therefore you can take exposure to that. So, I think people need to definitely weigh the options that they have and one can, of course, look at the Indian market in terms of growth and we subscribe to that. There are opportunities which may not be present in your home market for you to just be focused on, so just look outside.

Venkatkrishnan: Yes, I do. First, he has to experience the home bias. In the sense that he has to experience the Indian equities, how the returns have happened, how the wealth has been created over the last 10-15 years. That makes him more confident to invest in other markets and kinds and styles of funds. So obviously that is one of the criteria which I look at and if the investor has experienced that, then we can add that to his portfolio. This makes it easier for the person to understand. Now, let’s take the question about growth in India. Where is innovation happening? I think innovation happens in markets of the U.S. and you’d like to be a part of that innovation because it doesn’t happen in our country... I think that experience happens very simply with the allocation of funds that you have through the Indian offerings which are there abroad. So, I think it’s a way of experiencing that innovation and getting that advantage into your portfolio. Obviously, it has its own risks and volatility, but it is a thing allocating into your portfolio and seeing what long-term value it can add.

Venkatkrishnan: The first is mutual fund. This platform has not taken over. There are hardly any funds. There is just one fund which has some Rs 900 crore as funds in the international market. All other funds are much lower. It is just Rs 2,000 crore. I think the market still has to evolve. People still have to accept it so that you can go forward and get the reeds or any of those kinds of products which come in. You know we can experience the ones which are available, and I think, for example, you have the Franklin India Feeder Fund, you have the Edelweiss China Fund, the Kotak U.S. Equity Funds, the Brazil Fund. I think people have to understand what they add in their portfolios. It will happen over a period of time, say in the next five years, when people see the returns, when they see and experience what is being talked about. I think allocation would increase over a period of time.

Kothari: There are a couple of ways where you can have exposure to and I completely agree with Roopa is that when you take exposure through mutual funds, a couple of funds stand out—the U.S. flexible equities, gold or energy funds. The second way to take exposure is through the government, and what the RBI allows you, is by way of $250,000 per individual. With a family of four, a million dollars could be invested outside. But there are technicalities to it. There is gestation to it when you invest abroad and get registered abroad and at home market. It’s slightly cumbersome than an easy plug-and-play from an MF standpoint. The third aspect is through the healthcare fund which we launched recently, we’ve kept a portion of where we want to take exposure externally.

Within the healthcare, there are opportunities and as Roopa mentioned that where R&Ds are happening, where there are innovations, etc., so you want to be exposed to these companies. How do you take advantage of them? You keep some aspect of your portfolio that takes exposure outside, and that’s exactly what we’ve tried to do and we have invested in two of those companies within that strategy already.

Venkatkrishnan: If you look at a lot of funds, for example Parag Parikh Long Term Fund. It has got that element of the U.S. stocks. Its managers do valuations and buy stocks according to the opportunities available. If you don’t want to take 100 percent exposure to any of these funds, you can go through the PPFA mode.

If you look at the Franklin U.S. equity funds, it just gives you opportunities for the Apples and Googles. I think that all of these funds do give you the options that add value to your portfolio. In the past five-six years, you have got these companies coming here, doing their businesses. People are understanding the volumes, the way Netflix has come into Indian households. So now people realise what these companies are and how they can add value to your portfolio. So, it has to evolve, people have to understand, people have to come. When it happens, it will explode. It’s just is that it is in a nascent state, so I think, as the markets evolve, as the mutual fund industry evolves, as people come and experience that journey of earning wealth over a period of time, I think these funds will be a part of everybody’s portfolio over the next five to 10 years.

Kothari: Let’s take the U.S. flexible equity to start with. So, the U.S. flexible equity fund gives you the exposure to the U.S. markets.  So, if a foreign investor or any investor from the foreign market were to take exposure in India and invest in any of our strategies in India and not just DSP, he would get the best ideas across the market cap spectrum (large, small and mid cap), across sectors, companies which are doing well, you are trusting the fund manager who is in the captain’s seat and kind of trying to drive those returns with the expectations to deliver those returns in alpha over a period of time. And they also follow similar benchmarks.

Second, what if you want to take exposure to gold? That’s the way you play through the gold equities strategy. You may be bullish on a commodity but how you take on the advantage of investing into an equity of that commodity and take the upside? If you are bullish on cement, would you buy a few cement bags? Maybe not. But you would invest in one of the cement companies in India, right? In a similar fashion, if you are bullish on gold, why not buy gold equities or gold-mining companies? So, if that is possible, that is it.

These are the opportunities which you have and these come with fantastic fundamentals as well. So, it’s not just about playing gold, but they also have free cash flow and yields. They are into production. Their production is high, costs are going off, so you get better leverage in terms of gold prices.

Kothari: Absolutely right. In fact, that’s one of the biggest risks investors should keep in mind—sometimes correlations do break. So, ideally, when gold prices go up, gold equities should follow. But in a normal scenario, not in a geopolitical environment where gold prices go up because of the geopolitics or because of something that has gone wrong in the world or because people feel that the world is coming to an end, gold prices may go up but anything that has equities with it has to fall. So gold equity will of course fall with it so that’s the risk which you have to be cognizant of.

Venkatkrishnan: Not at all. Because in the end, it is the asset allocation. If you look at the journey of investments of any portfolio or any clients, is cost important? It is about how much of the portfolio return has contributed to creating that wealth. Over a period of time, the return comes out much beyond the expense that he has to pay for it. Nothing comes free. There is a cost to it. But over a shorter period of time, you’ll consider everything; returns, costs, etc. At the end of it, equity is for 7, 8, 10-year period to create that wealth and compound. Obviously, then it becomes very significant.

As an asset class, what is important is that 90 percent of your returns are only coming because you are in a particular asset class and that asset class is going to give a return. It’s not about anything else. And sticking to your plan and the goal. If you are in an international fund, obviously it has its volatility. For example, there have been times in the last 40 years, where first two decades the international markets have done better than India. But if you look at 1999-2000, period, I think the Indian market did much better than the U.S. markets. But now, the average is almost there if you look at the rupee return. You have to experience that whole period to get that return. That is where the cushioning will happen into your portfolio. For instance, U.S markets have done very well in the last six-eight months, but the Indian markets have not. If you had 5-10 percent of the portfolio,  it would have cushioned your returns.

Kothari: When you sight a good opportunity and it’s not also so co-related with other asset classes, it definitely gives you diversification. So, you need to focus on that. But costs are really are not very different from what you pay even in India so, I don’t think that should be a sticking point anyway.

Venkatkrishnan: That’s because of the size. If you have a NASDAQ fund there is a size because you have to go through the exchange. So, the cost is different than the mutual fund mode...

Kothari: One, risks in terms of the currency. When institutional investors or foreign investors, when they invest in India, from their risk point of view, it’s not good if the rupee depreciates. But it’s the reverse for an Indian investor investing outside. So, when the rupee depreciates, we kind of get more returns for the unit of risks that we put in. For example, I have put Rs 100 outside India, and when I convert it back, and the rupee has depreciated 5 percent, I get Rs 5 extra because of the depreciation. Also, because of the interest rate and exchange rate differentials, India is expected to depreciate on a consistent basis. So, that is one of the risks that you may have to keep in mind that you may be expecting a good return but the currency fluctuations may kind of eat away some of it.

Second, correlation. A lot of times, we expect and we invest outside. If I am getting a non-co-related asset class externally, I may want to invest into that. But in times like the global financial crisis or distress, all asset classes come off simultaneously. So, you were thinking of diversification, only to realise that all the asset classes have come down together.

Last, is the theme.

Venkatkrishnan: It’s all about time period. Everything has to have a time period. Now with gold, it’s cyclical. Everything has a cycle. When geopolitical issues happen, equities won’t do well but gold will. In gold, you cannot expect a return like that of equity. The appreciation of gold has been a 4 percent CAGR return over a period of time. That is a cyclical 4-5 percent if you take in the last 30-40 years. If you are going to come in with an expectation saying that I am going to get 15 percent return in gold, it is not going to happen. So, it is all about expectation of return when you come into an asset class. As Jay said, we can say that the U.S. equity market fund will give you around 6-7 percent but if the rupee depreciates, maybe it will add 2-3 percent more. But if the rupee appreciates, the return would come down. So those are all the risks that may happen in a shorter period of time if you’re looking at two, three, four years.

But if you come up with a longer horizon, I think the returns will actually stabilise. Again, you cannot expect a return in a foreign fund like the one which happens in Indian funds. Because at the end of it, it is all about the expectation of return as you have to compare apples to apples and oranges to oranges. If you invest in a foreign fund, it will give you a little more than the debt funds. Asset allocation is again an important thing. Just because you want to take an exposure to an international fund, you cannot take 50 percent into your portfolio. It has to be 10-15 percent of flavour into your portfolio.