Investing is all about passion and belief. The aim is to earn returns higher than estimates and achieve them constantly over time. So how do you do that? First, conduct thorough research of available assets and make suitable investments. Second, conduct an annual portfolio performance review and make necessary changes. These changes could mean rebalancing the portfolio or pertain to making goal adjustments. Thirdly, by ensuring that you maintain a well-diversified portfolio, managing the overall risks. And finally, search for newer avenues to invest. One such investment is international mutual funds. Is investing in international mutual funds the right choice?
International funds dedicated to the US, Europe, BRICS, African sub-continent, East Asia are available. These funds also exist as dedicated to emerging, developed economies. Further, investors can opt for international sectoral schemes focused on real estate, mining, technology, agriculture, manufacturing, etc., which invest in companies across the globe.
Essentially, accumulating a larger retirement corpus and beating your performance expectations are great motivators. And these factors urge you to take the driver’s seat and be an aggressive investor. That is the point where investors should restrain from making investment decisions. Being successful and achieving better returns has its charm. However, you must only invest with care and within the risk tolerance level.
Why invest in an international mutual fund?
A straightforward reason is that international mutual funds provide an element of diversification and help improve returns.
However, the crucial point is that investors must never follow their fascination to diversify or improve returns. Instead, there must be a need to diversify beyond a certain level.
The urge to constantly find better avenues to invest is a double-edged sword. It is good to explore newer geographies, but India is one of the growth hubs of the world. And there are numerous mutual fund investment options available in India across categories of equities, debt, hybrid, etc. Therefore, you must have good reason to venture out to economies outside India.
What is an international mutual fund?
As the name suggests, international mutual funds invest in foreign companies. Given their objective of investing in foreign companies, these mutual funds are also called overseas or foreign funds.
The risk exposure is high while investing in an international mutual fund. One of the primary reasons is the inability of investors in the home country (for instance, India) to monitor economic and financial development across other countries (where the funds get invested). Although investors do not have to keep an eye on foreign economies continually, a general understanding always helps.
It is critical to understand the risks you partake during the investment journey. Taking calculated risks is one arm of investing protocol. The other leg is that the investors wish to enhance returns and find alternative investment options. An international mutual fund is one such avenue.
In other words, being aware of the risk is one aspect, and tapping into earnings potential is another aspect. International funds are one such combination that could increase risk and enhance returns. Further, international mutual funds provide portfolio diversification opportunities and reduce dependency on a single economy.
Who can invest in an international mutual fund?
An option to invest in an international mutual fund is clearly for active investors. In other words, an investor needs an understanding of financial targets, risk profile, long and short-term goals and possess clarity on why to invest internationally.
Very evidently, there is a multitude of options to invest in India. So, only savvy investors who understand investments deeply must venture out internationally. These investors know the reasons why they should diversify internationally. Here is a summary –
First, different countries have different growth cycles. Understanding foreign markets allow investors to put in money at the right place at the right time and eventually benefit from the upcycle. Second, international funds provide diversification. Third, even though the assets are similar (like equities, debt, real estate, treasury bills, commodities, etc.), the underlying economics are different. Finally, global investing broaden investors’ horizon of knowledge and helps them develop expertise.
What should investors be aware of while investing in international mutual funds
Investors should understand the bottom line – every coin has two sides. In other words, there are pros and consequences to investing in international mutual funds. Therefore, every investor must understand both aspects before concluding. Here are the fundamental guiding principles:
- Thoroughly research the country (or countries) where you would like to invest your funds. Or the region where the mutual funds will eventually invest money
- Understand the investment objective of the international mutual fund – align the funds’ goal with your investment goal – and then both you and the mutual fund share the dream
- The basics of investing still hold good – like should you invest in stocks or mutual funds? Which is better amongst index funds or index ETF?
- Know when to sell a mutual fund
- Consider the international mutual funds as one category of investment within your portfolio. In other words, do not allocate more than 5-10% of the total portfolio in international mutual funds
Read here to understand how to choose suitable mutual funds.
What are the risks of investing in an international mutual fund
In terms of their functioning, international mutual funds are similar to any other mutual fund. Therefore, the generic shortcomings applicable to any mutual fund investment apply. For instance –
- Timing investments is not possible
- Investors cannot apply advanced investing techniques like options, futures, short selling, etc.
- Stock selection is a prerogative of the fund manager – investors cannot invest in niche stocks based on their research
- Expense ratios can be high in some instances
However, investors should consider a few more specific risks for international mutual funds. These may or may not apply to domestic investing. And, even if they do, the scale might vary. In short, understanding these will help investors make a thoroughly informed decision. Here are those key risk factors:
Exercise global vigilance
Global financial, political, economic and social aspects impact the capital market performance of countries. So, investors must keep an eye on developments across the international markets.
High expense ratios
The expense ratios differ whether the mutual fund self-manages the fund or invests in other mutual funds. The expense ratio (ER) can be as high as 1.5%, impacting the overall returns.
Expense Ratio (ER), also called Management Expense Ratio, measures how much of the fund’s assets get spent on operating and management expenses. ER is derived by dividing total operating expenses by average assets under management. The lower the ER, the better it is for the investors.
Sectoral impact within the economy
We spoke about economic developments having an impact. While you can consider this point an extension of the above, we believe this risk factor deserves a separate mention. Why? Broader economic performance is one aspect; sectoral performance is another equally important factor (if not more).
For instance, consider the market is doing good, but real estate is not performing. And you have invested in a real estate sector focus fund. Eventually, while investing in the country was the right decision, investing in the real estate sector proved wrong. So, ultimately, you remain devoid of higher returns as you expected.
Higher risk factor
Investors choose international mutual funds to diversify their portfolios and enhance portfolio performance. On the one hand, there is scope to achieve superior income, but on the other hand, there is a downside too. The number of factors that bear on the returns is numerous. That gets compounded by the number of countries you (or the mutual fund) invest in, thereby multiplying the risk.
Currency related risk
The ultimate objective is to achieve returns in home currency, which is the currency of your portfolio. That is true even though you invest in other currencies. Therefore, the movement in exchange rates plays a critical role in calculating returns in your home currency.
For instance, you invested Rs10,000 on January 1st, 2022, in the US mutual fund. (Exchange rate of USD 1 = Rs 80). The net amount invested in the investing country is USD 125. Now, as of December 31st, 2022, assume your portfolio returned an amazing 20% return and stood at USD 150. Due to appreciation in rupee (vs the dollar), the exchange rate at the end of December is USD 1 = Rs 75. In that case, when you convert the fund back to home currency, you will get Rs 11,250, or a moderated return of 11.25% p.a. This, of course, is not assuming any impact of taxes.
Returns from international mutual funds are subject to local taxes. In addition, any earning from such investments can be taxable to taxes in the country in which income got generated. As an outcome, there could be an impact (or double impact) on net income due to applicable tax laws and inefficiencies.
Advantages of investing in an international mutual fund
As said earlier in the article, every coin has two sides. In other words, there are risks to investing in international mutual funds, but there are also advantages. There are two main advantages – portfolio diversification and better risk-adjusted returns. But, this is not enough. There are a few more than these two obvious ones.
We take it for granted that you are a savvy investor since you are investing in international mutual funds. In other words, we assume that you have an opinion of how the value of your (home) currency will move vis-à-vis the destination currency.
Continuing the above example, assume that you predict that your home currency (rupee in this example) will devalue vs the destination currency (dollar in this example). In that case, you can take advantage and enhance the overall return from the investment.
So, assume that due to depreciation in rupee (vs the dollar), the exchange rate at the end of December is USD 1 = Rs 87. In that case, when you convert the fund back to home currency, you get Rs 13,050, or an accentuated return of 30. 5% p.a. without any taxes.
Invest in growing economies
Alike business cycles of ups and downs, the capital markets also have their performance trends. One country cannot continue to deliver superior returns continuously over time. Therefore, investing in international mutual funds allows investors to invest in various countries, gaining benefit from the economic cycle of several countries. In other words, add performance peaks of different countries to your portfolio simultaneously and enhance returns.
Allows investing in global leaders
International mutual funds allow investors to invest in global companies that are leaders in their segment (or sector).
For instance, FAANG represents the five most prominent American technology giants. As a result, it is a prevalent investment option in the technology sector. The mutual fund would invest in Meta (formerly Facebook), Amazon, Apple, Netflix, and Alphabet (formerly Google) stocks.
Invest in cheaply valued equities
Let us explain through an example. The recent run in the market has brought the valuation multiple of Indian equities to a high. And, there could be several reasons for a premium valuation.
However, the idea is not to ascertain why the premium. Instead, the point is that since the Indian equities are expensive, investors may want other reasonably valued options to invest their funds. Herein, these international mutual funds come as an option. In other words, investors get an opportunity to invest in other countries where the valuation premium is not yet at its peak. As a result, investors have a higher chance to generate better returns.
Investing in international mutual funds broadens the available investment avenues. As a result, the landscape expands from the asset classes in the home location to the same or more asset classes in many other countries.
Manage overall risks
The overall risk is high as you invest in international mutual funds. However, within that, your portfolio can still be a combination of high-medium-low risk investments. How?
Compensate investment in a high risk and high return country by investing in geography with low risk and low-medium return. That way, you can manage the overall portfolio risk and return.
Investors often start their international markets investment journey along with experts. As a result, investors gain knowledge and understanding of global markets and economies worldwide. This familiarity with the worldwide investment space helps investors gradually become proficient.
A sneak-peak at top-performing international mutual funds
Here are some examples of top-performing international mutual funds.
Do note there are more than a few dozen schemes available for investment. To provide a glimpse, we have applied the below filters to ascertain the top five mutual funds:
- Assets under management (AUM) of more than Rs 1,000 crores
- Direct plans under growth option
- Returns sorted as per 3-year annualized returns
The data is as per www.moneycontrol.com, and NAV, returns are as of February 18th, 2022.
|Scheme Name||3-Yr returns||5-Yr returns|
|Motilal Oswal Nasdaq 100 Fund of Fund||29.0%||–|
|Edelweiss Greater China Equity Off-shore Fund||21.1%||18.2%|
|PGIM India Global Equity Opportunities Fund||20.8%||17.9%|
|Franklin India Feeder – Franklin US Opportunities Fund||19.8%||19.0%|
|ICICI Prudential Asset Allocator Fund||15.1%||12.9%|
The decision to invest in the passive or active mutual fund also applies to international mutual funds. Read more about this concept here.
The bottom line – is investing in international mutual funds the right choice?
Above all, it’s an investment in a mutual fund. Of course, the ultimate investment avenue is different, but the basics of investing in mutual funds continue to apply. Two themes emerge in this context: diversification and improving earnings.
International mutual funds are high-risk assets, and sectoral funds (in global geographies) are even riskier. Therefore, retail investors should avoid exposing themselves to such avenues.
After conducting adequate research, international mutual funds can be an investment area for savvy investors. These investors get an opportunity to diversify geographically and participate in the global arena.
As a rule of thumb, do not invest more than 5-10% of the total portfolio in international mutual funds. At least, unless you have solid reasons to increase the exposure.
The times are uncertain, and the announcement of financial packages to boost economies has become a norm. But, based on sustainable earnings, every market will eventually get valued at the mean earnings multiple. So economies that appear to be highly appealing today due to packages and reliefs will have to perform to sustain the valuation. If the performance does not meet expectations eventually, those markets will collapse.
In conclusion, investments in international mutual funds are a subject of expertise. Keep in mind that all that glitters is not gold, and risk-adjusted returns are the right measure of evaluation. Therefore, investors must only invest in international mutual funds if they are highly convinced about the prospects. You can follow the three-step process to arrive at the investment option if the decision is final.
- Choose the segment – equity, debt, etc.
- Identify the geography and sector you want to invest
- Compare the available funds and their performance vs the benchmark
About the author
The author is a senior finance professional with over fifteen years of work experience in corporate finance. He has an affinity for matters relating to personal finance and investment management. The author wants to share his knowledge and understanding of the subject through his writing.
The author has used his knowledge, experience, and understanding of the subject and has exercised extreme caution to avoid possible mistakes. However, the author does not take responsibility for any error that exists.
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Under any circumstances, the author shall not be liable for any views or analysis expressed in this note. Further, the opinions expressed are not binding on any authority or Court. We advise readers to consult their financial advisor for assistance in their specific case.