The rupee has steadily weakened to touch an all-time low of 72.5 a dollar, hit by concerns over a global trade war and a widening current account deficit.
However, investors can actually benefit from the sliding rupee over the medium to long term by parking some money in an international fund.
Nullify currency impact
When you put money in an international fund, the money is invested in that particular overseas market in dollar denominated assets. The change in price of these assets—foreign equities or bonds—during the period of your investment primarily drives the return of the fund. But apart from the performance of the underlying portfolio itself, the movement in the dollar-rupee exchange rate also contributes to the fund’s return.
Since the final net asset value of the international fund is arrived at by converting the value of the dollar assets into the local currency, the exchange rate fluctuations play a key role in the fund’s return profile. A weaker rupee relative to the dollar adds to the actual return from the fund, while a stronger rupee can put a dent in the fund performance. This is visible in the return profile of international funds in recent years.
US focused equity funds have fared well in recent years
3 and 5 year returns are annualised. Source: Value Research. Data as on 10 Sept 2018
Certain US focused equity funds in particular have benefited from the currency movement in the past few years. For instance, the Motilal Oswal Nasdaq 100 ETF has clocked 20.4% annualised returns over the past five years.
However, the underlying index has actually gained 18.6% in dollar terms during this period. The additional return from the ETF is owing to the 2.4% annualised appreciation in the dollar during this period, excluding the impact of expense ratio and tracking error. Similarly, the DSP US Flexible Equity Fund has clocked 13.25% annualised returns over the past five years, even as the NAV of its underlying fund, BlackRock Global Funds-US Flexible Equity Fund, has gained 12.74%.
Again, the additional return is owing to the rupee depreciation. An international fund can help investors hedge the currency risk to the domestic portfolio. “Being a developing economy with a higher inflation trajectory, the local currency is likely to continue to depreciate against the dollar over the years. Its impact can be nullified to some extent with an international fund,” says Amol Joshi, Founder, PlanRupee Investment Services.
Gain from geographical diversification
However, hedging currency exposure cannot be the sole reason to consider an international fund. The biggest benefit of opting to invest in foreign equities is bringing geographical diversification to the portfolio. By investing overseas, you prevent the portfolio from becoming entirely dependent on the performance of the domestic market.
At times when the domestic economy and markets are going through a tough phase, having exposure to a better performing overseas market can lend stability to the portfolio. “Since the Indian market has very low correlation with some of the overseas markets, having global exposure ensures healthy diversification,” contends Prateek Pant, Co-founder and Head of Products and Solutions, Sanctum Wealth Management whose firm offers a Global Allocator strategy using the PMS platform to enable clients to diversify geographically.
Besides, investing in international funds is no longer tax inefficient compared to investing in domestic equity funds. Earlier, gains from domestic equities attracted no tax if held for a year, even as gains from an international fund were taxed at the marginal rate if sold before three years, after which gains were taxed at 20% with indexation benefits. Now, with domestic equities also facing 10% tax on capital gains after one year, investing in international funds is no longer a tax-negative proposition.
Planning for foreign currency expenses
This avenue is particularly worthwhile for those planning to send their children abroad for higher studies or even considering a foreign vacation at some point in the future. Given that the effective cost of foreign education or a trip is likely to go up as the rupee weakens, investment in an international fund can help partially offset the impact of any adverse exchange rate movements.
In fact, some experts insist that planning for a goal such as foreign education or vacation should involve investment in an appropriate international fund. Joshi says, “Putting some money in an international fund makes sense for anyone with certainty of future expense in dollar terms.” Out of every Rs 100 allocation towards any financial goal involving foreign currency exposure, Joshi suggests putting Rs 25-30 in an international fund while the rest can remain invested in domestic assets.
Maintain simplicity and discipline
The choice of international fund, however, is critical given the plethora of themes on offer in this category. Planners recommend a simple US dedicated equity fund for the required international exposure, given the stability of the US market. Other more exotic offerings—targeting other geographies or specific investment themes—may do more harm than good to your portfolio. Pant insists that investing in a global fund should not be a one-time exercise. “Investors should follow the same investing discipline with their international allocation as their regular domestic investments,” he says.
