International Mutual Funds: What are they and how to choose the right one

What are International Mutual Funds?

As mentioned earlier, International Mutual Funds primarily invest in Equities and Equity-linked assets of foreign countries. The definition provided by the Securities Exchange Board of India (SEBI) is more detailed and defines an International Equity Fund as a scheme that invests 80% or more of its assets in Equities or Equity-linked assets in a foreign country. By this definition, there are currently 44 different International Funds in India that manage over Rs.15,000 crores in assets.

As this definition includes a significantly large number of Mutual Fund schemes, it is easier to understand the different types of International Funds available to Indian investors based on key aspects of the scheme such as structure, investment geography, and style of investing.

FoF and Direct Investing:  How International Funds Invest Your Money Overseas 

Out of a total of 44 International Funds currently operating in India, domestic AMCs themselves manage only 7 schemes while the remaining 37 funds are managed using a fund of funds (FoF) structure.

A fund of funds (FOF) is a type of Mutual Fund in which a Feeder Fund (the Mutual Fund available to Indian investors) invests in another Mutual Fund (the underlying fund) that invests in international markets. In this structure, the manager of the Indian Mutual Fund does not directly buy or sell the stocks of International companies, instead, he/she purchases units of another Mutual Fund, and the manager of the second Mutual Fund is involved in managing the international investments.

For example, the recently launched SBI International Access US Equity Fund invests the money collected from Indian investors in the Amundi US Pioneer Fund. Amundi US Pioneer Fund makes international investments and holds the Equity stock of international companies on behalf of its investors.

Other Fund Houses that use the FoF structure in case of International Funds include  DSP Mutual Fund that invests in Mutual Funds managed by BlackRock, Edelweiss Mutual Funds which invests in Mutual Funds managed by J.P. Morgan, Axis Mutual Fund which invests in Mutual Funds of Schroders, and Aditya Birla Mutual Fund that invests in schemes managed by Julius Baer. In the case of Fund Houses such as Franklin Templeton India, Invesco India, PGIM India, Principal India, and HSBC India the International Funds of the Indian arm invest in Mutual Funds managed by their parent companies that operate in various international markets.

Expense Ratio of International Funds: A Mix

When an International Fund follows a Fund of Fund structure, there are two different Mutual Funds involved – the Feeder Fund where the Indian investors invest, and the underlying fund in which the Feeder Fund invests. Both the feeder fund and the underlying fund have separate management expenses which need to be paid by the investor. The below table shows the Expense Ratios of a few leading International Funds:

As you can see, DSP Mutual Fund and Edelweiss Mutual Fund have included the expense of the underlying scheme when reporting the Expense Ratio of the fund that the Indian investor invests in. On the other hand, Franklin India Mutual Fund and Invesco India Mutual Fund have not included the Expense Ratio of the underlying scheme. As a result, while the expense ratio of Franklin India and Invesco might appear to be lower, that might not actually be the case as the Expense Ratio of the unlying scheme has not been included.

To help you reduce the confusion resulting from this difference in the style reporting Expense Ratios, you can check the Expense Ratio and key details of all 44 International Funds by downloading the ETMONEY International Fund Worksheet here

Where do Different International Mutual Funds Invest and Why It Matters

International Mutual Funds in India currently offer investors multiple options in terms of the geographical locations where they can invest. Some of the popular investment choices of these schemes include countries like Japan, China, the ASEAN countries, Europe, Brazil, and the United States. In case you do not want to limit your investments to a particular Geographical region, you also have the option of investing in International Funds that have a mandate to invest Globally.

Depending on the country/region where the International Fund invests, these schemes can choose different benchmarks that they try to beat. Each of these benchmarks will have a different Price to Earnings (P/E) ratio and their ability to provide future returns also differs. As a result, there will be significant variation in the performance of different International Funds depending on the Geographical area where they primarily invest. The below table shows the Trailing and Forward P/E Ratios of different Indices used by International Funds:

As you can see, all of these Indices have different P/E Ratios as they vary in their stock selection as well as the sectors/themes included in the Index. As different International Funds use different Benchmark Indices that they try to beat, their performance is bound to vary based on their chosen benchmark. So in order to understand the prospect of the future return of your International Fund investments, you need to take a close look at the Geography where the fund primarily invests as well as the scheme’s chosen Benchmark.

Picking International Funds based on Investment Style: The Options Available

In order to classify International Funds based on their investment style, you can use 4 key parameters – Theme/Sector of the fund, Growth or Value Fund, Market Capitalisation, and Active or Passive Management of the Fund.

  1.  Theme or Sector of the International Fund

Many International Funds invest according to a specific theme or into a specific sector – such as Energy, Mining, Agriculture, Consumer Cyclical, etc. Some other schemes have a more diversified approach to making investments. Currently, 25 out of the 44 international Funds available in India follow a diversified investment approach, while the remaining 19 schemes have a thematic or sectoral approach. The below table shows the number of funds available to the Investor based on their thematic or sectoral approach:

In the table above, you can see that International Funds offer you a wide range of investment options depending on the type of theme or sector that you want to invest in.

  2.  Growth Style or Value Style of Investing

Among the 44 International Funds currently available in India, 17 schemes follow the Growth Style while 7 more follow a Value Approach to selecting investments. The remaining 20 funds in the category follow a blended approach i.e. part growth and part value style of investing. Depending on your preference you can choose to invest in an International Fund that follows a Growth Style, Value Approach, or a Blended style of investing.

To know the investment style of different International Funds you can download the ETMONEY International Fund Worksheet from here.

  3.  Market Capitalization 

Currently, a majority of International Mutual Funds in India invest primarily in the equities and equity derivatives of Large-Cap Companies. Hence, you do not currently have a significant number of choices in case you want exposure to Mid-Cap or Small-Cap equities through International Funds. The only exception to this general rule is a few theme-based funds and the Principal Global Opportunities Fund.

The Principal Global Opportunities Fund needs special mention as it is currently the only International Fund with a bias towards Small Cap equity investments and it uses the MSCI All Country World Small Cap Index as its benchmark.

4.  Active vs. Passive Fund Management

In the case of International Funds, there are currently 3 schemes that follow a passive approach to fund management as they track the performance and composition of International Indices. These schemes are:

• Kotak NASDAQ 100 Fund of Fund
• Motilal Oswal NASDAQ 100 Fund of Fund
• Motilal Oswal S&P 500 Index Fund

All other International Funds in India are actively managed. So if you are looking to invest in a specific International Index, you can choose one of the 3 passive funds otherwise you can opt for the actively managed international schemes.

Investing in International Mutual Funds in India: A Snapshot of the Key Benefits 

International Funds have become popular over the past couple of years due to the various advantages that they offer Indian investors in terms of:

• Diversification in terms of Geography and Investment Themes
• Weak correlation to the Indian markets i.e. International Fund performance is minimally impacted by Domestic Market movements
• Potential to deliver higher returns when the Indian Rupee decreases in value
• Opportunity to invest in ideas and themes that are generally not available in the case of domestic Equity Funds.
• Superior performance with 75% of International funds posting higher returns than the NIFTY 50 over the last 5 years.

Choosing Your International Fund: 3 Steps to Follow

Due to the many benefits mentioned above, you should definitely consider including International Funds as part of the overall asset allocation strategy for your investment portfolio. This leads to the question of how you can choose an International Fund that is the best fit for your investment portfolio. There are no hard and fast rules to select the best International Fund for your portfolio. But there are some steps that you can take to select an International Fund that suits your investment goals:

• Step 1. Identify the sub-category of International Funds that will be the best fit for your portfolio

Using an idea similar to selecting Domestic Equity investments for your portfolio, you should consider investing in International Funds with a diversified portfolio instead of thematic schemes such as Mining or Agriculture.

• Step 2. Choose the geography or location you want to invest in

In recent years, countries and regions such as Japan, Brazil, and Europe have been underperforming and their future growth prospects are also uncertain. Based on this fact, you can narrow down your choice of International Funds to those investing Globally or those investing in the US, China, and Emerging Markets. If you do not have a preference among these as your investment destination, choosing International Funds that invest globally is the best option for you.

• Step 3. Compare the performance of funds to Benchmarks and focus on consistency of returns

As mentioned earlier, International Funds in India can choose different Benchmarks, which have different growth potential, which leads to a variation of returns among different schemes. So, instead of just focusing on returns, you need to focus on the consistency of returns offered by the scheme as well as the performance of the International Fund versus its chosen benchmark when making your selection.

After completing the 3 steps mentioned above, you should be able to narrow down your International Fund choices to 2 or 3 from the original universe of 44 International Funds. After this, you should take into account the Expense Ratio and characteristics of the scheme such as Investment Style (Value, Growth or Blended) and Fund Management Style (Active or Passive), which were discussed earlier, and make your final selection.

Bottom Line

Including International Funds into your investment portfolio can offer you significant advantages by reducing the overall risk in your investment portfolio while simultaneously maximizing overall returns. As with Domestic Mutual Fund investments, you should consider using a Systematic Investment Plan or SIP strategy to invest in and stay invested for the long term in International Mutual Funds.