Do domestic-global funds work for you?

Motilal Oswal Nasdaq ETF, an international mutual fund, with a CAGR (compounded annual growth rate) of 16.15% comes within a whisker of being India’s best performing mutual fund over the past five years (as on 6 October 2019). Yet Indian investors have largely missed out on it and similar high-performing international mutual funds. The overwhelming majority of their money is into funds investing in domestic stocks.

In fact, India is only about 8% of the world’s GDP in purchasing power parity or PPP terms, which shows that, broadly, Indian investors are not participating in the economic growth of the remaining 92% of the world. This is mainly because investors are more familiar with the domestic Indian market. This phenomenon is called “home country bias”. Some of the diffidence is due to taxation—international funds are taxed like debt funds. Investors pay tax at their slab rates for holding periods of less than three years and at 20% with indexation, thereafter.

So what’s the solution? One possibility is the “domestic-global” model PPFAS Mutual Fund is following for PPFAS Long Term Equity Fund. The scheme invests at least 65% of its assets in domestic stocks and the balance in foreign equities. This allows investors the benefit of equity taxation, while retaining a more diversified structure than a traditional equity fund. A growing tribe of equity funds is adopting this model, possibly opening up a whole new category for Indian mutual fund investors.

The combo funds

PPFAS Long Term Equity Fund, which was launched in 2013, can take up to 35% exposure to international stocks. At present, it has invested in international stocks, including Alphabet (10.93%) the company that owns Google, Facebook (4.97%) and Suzuki ADR (4.97%). The fund is benchmarked against S&P BSE 500 Total Returns Index (TRI). Indian fund managers, Rajiv Thakkar, Raunak Onkar and Raj Mehta directly pick both Indian and international stocks that the fund invests in. “Our direct model is more cost-effective than investing in a feeder fund as an Indian investor pays an additional layer of fees in a feeder fund. Also, the overseas fund would optimize for its home country investors while our stock picks would be tailored to diversifying from an Indian basket,” said Thakkar. The fund has delivered a return of 11.01% CAGR over the past five years compared to 8.60% given by the S&P BSE 500 TRI.

Axis Asset Management Co. launched a similar offering called Axis Growth Opportunities Fund in October 2018, benchmarked to the BSE 200 TRI Index. As of August 2019, it had 18% of its corpus in international stocks, including Alphabet, Visa, Home Depot and Nestle SA.

Following up on the trend, Kotak Mutual Fund has proposed the launch of Kotak Pioneer Fund. The new fund offer (NFO) is scheduled to run from 9 to 23 October. The USP of the fund is that it will invest in innovative or pioneering businesses both in India and abroad. “Our endeavour is to pick companies which are increasing their market share through new products, services and processes. Such a portfolio is not complete if we only focus on the Indian market and that is why we will take up to 35% exposure in global innovators,” said Harish Krishnan, fund manager of Kotak Pioneer Fund. “We will do this by investing in CI Signature, a Canadian fund house which invests in global innovative tech companies. Around 70-80% of the foreign portfolio will be in US tech majors,” he added.

Slice of foreign stocks

Thakkar laid out the four main advantages of international investing. “First, different markets do well at different times so you should not restrict yourself to the Indian market.” Over the past six months, the S&P BSE 500 TRI is down 5.82%, while PPFAS Long Term Equity Fund is down only 0.55%. “Second, many Indian sectors like IT and pharma derive their revenues from abroad, so you should also evaluate their global counterparts. Third, some sectors like e-commerce are only listed abroad in a significant way and not in India. Fourth, the parent is sometimes more attractively valued than the Indian subsidiary. For example, Suzuki compared to Maruti Suzuki,” he said.

One of the key advantages of the international exposure is the benefit of rupee depreciation. However, not all funds take direct advantage of this. “We hedge about 70-80% of our foreign stock exposure. This doesn’t mean that we give up on the advantage of rupee depreciation. The spot-forward differential gives us a 4-5% return on our currency hedge,” said Thakkar.

Financial planners also like domestic-global funds better than international funds. “I would recommend a fund with up to 35% in international stocks rather than a pure international equity fund,” said Nishith Baldevdas, founder, Shree Financial, a Chennai-based independent financial adviser. “The latter types of funds are just too volatile. They are also at a disadvantage compared to the former in terms of tax,” he said.

A domestic-foreign combo fund is a good option for investors with moderate risk appetite who are looking to dip into foreign markets.