Equity Diversification: Look beyond EMs, China

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New Delhi | Published: August 1, 2015 11:05:52 AM

The volatility in the Chinese equity markets over the last couple of months along with the rigorous measures adopted by the country’s regulators have shaken investor confidence worldwide.

CHINA stock marketThe volatility in the Chinese equity markets over the last couple of months along with the rigorous measures adopted by the country’s regulators have shaken investor confidence worldwide. (AP)

The volatility in the Chinese equity markets over the last couple of months along with the rigorous measures adopted by the country’s regulators have shaken investor confidence worldwide.

While several international funds are currently available to help investors gain exposure to equity markets like the US, China, Russia, Brazil and Japan, among others, a look at the performance of all these schemes shows that the emerging market schemes and commodity linked global funds have been poor performers.

In fact, as a category, international funds have by-and-large lagged in performance. Against an average return of 21 per cent generated by the large- and mid-cap domestic funds over the last one year, international funds have shrunk by 5.96 per cent. They have been weak performers even over three- and five-year periods, with average annual returns of 4.5 per cent and 3.8 per cent, respectively.

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Also, as a category, international equity and gold funds have been the worst performers in the last five years. Within the group, the only exception has been the schemes that invest in the US and Japanese equities.

Not only have the US-dedicated funds garnered notable assets under management (AUM) from Indian investors, but have also generated strong returns since their launch, thereby making a case for investors to look carefully before diversifying geographically.

While fund managers argue that a country-wise diversification is important for an evolved investor, they do not seem to be vouching for a majority of emerging markets and commodity linked global funds.

Over the last five years, fund houses in India launched 23 international funds taking the tally to 43. However, as Indian investors are still evolving and are learning the tricks of investing in mutual funds, these schemes found few takers. Not to miss the shrinking returns generated by a majority of them.

“While one can avoid commodity-dependent economies and some emerging economies for diversification, it makes sense to invest in funds that are putting money in the US and Japan as these economies are stable, have strong companies trading and also hold currency related benefit for investors,” said Sundeep Sikka, CEO, Reliance Mutual Fund.

Avoid emerging market and commodity oriented funds

The two categories of funds have performed poorly over the last few years. While BRIC (Brazil, Russia, India and China) forms a large part of the emerging market, a fall in commodity prices, including that of oil, weakening Chinese economy and reduced demand in Europe has exposed the vulnerabilities of the export and commodity-driven economies. However, India is projected as the only country standing tall and growing at a fast pace. If a rising dollar has made a lot of the emerging market currencies look weak over the last few months, a yo-yoing Chinese market over the last couple of months exposed the weakness of the Chinese economy and also shook the confidence of global investors in the markets.

Since China is expected to witness a slowdown in growth, several other emerging markets, whose growth is linked to the manufacturing sector in China, will also witness a slowdown and that only suggests that investors should stay away from emerging market funds.

While all these factors paint a weak picture of the future of the emerging markets, experts say that India will be the biggest beneficiary of this development as it will attract a higher share of emerging market fund flows and thus investors would benefit most by putting their money in the domestic market rather than looking at other emerging markets.

“India is one of the best markets to be in. The emerging market and global commodity-related funds are not performing well and one should avoid them. Right now they are contrarian value opportunities but the trigger point is not known. So the best bets are Indian equities, fixed income and US equities,” said S Naren, CIO, ICICI Prudential AMC.

Investment advisors always point that international funds are meant for diversification for evolved investors who understand the markets and already have sufficient exposure to the domestic markets ,but before you do that it is essential to know where to diversify.

Some point that investment should be into well-regulated markets that are liquid, the fundamentals of the economy are strong and there is a healthy corporate activity and growth in the country.

While the worst performing emerging market fund has been the HSBC Brazil fund that has generated a negative return of 43 per cent over the last one year, the worst performing commodity-related fund has been Birla Sunlife Global Commodities fund that has generated a negative return of 28 per cent in the same period.

The exception: US and Japan

Among the international funds, all the US equity-oriented schemes have generated more than 10 per cent return over the last one year. The best performing fund has been Franklin India Feeder Franklin US opportunities that generated a return of 22.3 per cent during the period. Reliance has a Japan equity fund that has grown 11.5 per cent over the last one year since its launch in August 2014.

If the prospects of better US economic growth augurs well for the US equities markets, a rising dollar and a hike in interest rates in the US will only result into outflow of funds from the emerging markets that in turn will weaken them further making the US look even better.

Even though experts caution against taking a view on currency while investing in US equities, an appreciating dollar only makes US equities look more attractive as the returns for Indian investors would rise if the rupee depreciates. Experts suggest to take a call on the US economy and invest to benefit from gains in some of the best and most profitable companies of the world.

Though all can benefit, individuals who plan to send their kids abroad for studies or have any major future planned expense abroad should look to take exposure to these schemes.

“In the next five years I plan to send my daughter who is now 13, for her higher studies to the US and for the same I have started routing my savings for her studies into one of the schemes investing in US equities. Not only it protects me from any adverse movement in rupee but also helps me to take advantage from growth of some of the best companies in the world,” said a top official with a financial services firm who did not wish to be named.

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