A quick guide to investing in international mutual funds
A checklist that helps an investor learn what to look for in an overseas mutual fund
Just like international travel and cuisine, we seldom look beyond our home country’s shores when it comes to investing. And investing in mutual funds in India is not the only other option.
Apart from India, which is the home to the most diverse number of mutual funds, there are plenty of investing opportunities which are often missed, just because we haven’t explored the option.
Investing in mutual funds in India is not the only other option.
International investing is one of the best way in which one can not only get a chance to discover new investing opportunities but also get a chance to diversify their portfolio with a variety of investment options, which are likely to be missed when we do not look beyond domestic investing options.
What are international funds?
International funds, also known as international mutual funds, are basically mutual funds which invest in companies that are located outside the investor’s country of residence. They are also known as foreign funds.
Further, to help investors manage their portfolio, investment decisions related to international funds are taken by experienced portfolio managers, who have expertise in terms of management of funds in the international market.
To further help investors in their investment decisions, fund management companies have research analyst teams located internationally to provide feedback.
Types of international mutual funds
• Global funds:
Even though they sound synonymous, global funds and international funds are not the same. Funds available across the world, including the home country, are global funds. On the other hand, foreign funds are those available only in other countries.
• Regional funds
If you invest abroad, focusing on a geographic region, then it becomes a regional fund. Sometimes investors even buy multiple regional funds rather than investing in global funds with presence across nations.
• Country funds
When you invest in a fund only available in one foreign country, it’s called a country fund. Hence, it becomes easier for you to study their market and decide accordingly.
Sometimes investors even buy multiple regional funds rather than investing in global funds with presence across nations.
• Global sector funds
A global sector fund gives close attention to a specific sector of the economy in overseas countries, and the global sector suits investors interested in that sector. Therefore, they mainly aim for exposure to an industry.
What to keep in mind when overseas investing?
As an investor, with about 10,000 mutual funds from a plethora of fund management companies to choose from, it helps to set some goals to narrow the field – like with any investment.
To gain some clarity on your investing goals, ask yourself whether you’re purpose of gains is either to fund a college education or accumulate for a far-off retirement. This will then help you understand how long you need to keep the money invested (time horizon), whether short or long term.
In terms of risk tolerance, it's important to decide where you sit on the risk continuum. Again, ask yourself, can you tolerate a portfolio that may have extreme ups and downs and are you more comfortable with a conservative investment strategy.
When thinking about the best time horizon for your investments, or how long you need to invest your funds, question whether you need your funds to be liquid in the near future or are you investing money that you can afford to have tucked away for many years.
• Understanding fund expenses
Mutual funds charge annual management fees for their efforts—and some may be more expensive than others.
The average international fund incurs annual expenses of about 1.5 per cent based on the total of the fund's assets.
So, when you invest Dh10,000 in a fund, Dh150 goes into the management firm's pocket each year. That might not sound like much, but if you’re investing for a long horizon, those fees can add up to serious money.
When you buy individual stocks, however, you pay the brokerage commission once, and then you’re done until you decide to sell.
All else being equal, you want to own funds that have the lowest possible expense ratio.
If two funds have expense ratios of 0.50 per cent and 1.5 per cent, respectively, the latter has a much bigger hurdle to beat before money starts flowing into your pocketbook.
Over time, these seemingly paltry percentages can result in a huge difference in how your wealth grows.
• Buy no-load mutual funds
Some mutual funds charge what is known as a sales load. This is a fee, usually around 5 per cent of assets, that is paid to the person who sells you the fund.
Sales loads can be a great way to make money if you are a wealth manager, but if you are putting together a portfolio, you should only buy no-load mutual funds.
If you invest in no-load mutual funds, your money will go into the fund and every penny — the full Dh100,000 — will immediately be working for you.
If, however, you buy a load fund with, say, a 5.75 per cent sales load, your account balance will start at Dh94,250. Assuming an 11 per cent return, by the time you reach retirement, you'll end up with Dh373,755 less money as a result of the capital lost to the sales load.
So, always buy no-load mutual funds, although these might not be easily available it is an upcoming trend.
• Avoid funds with high turnover ratios
It’s important to focus on the turnover rate—that is, the percentage of the portfolio that is bought and sold each year—for any mutual fund you are considering. The reason being taxes.
If you are investing solely through a tax-free account this is not a consideration, nor does it matter if you manage the investments for a non-profit.
For everyone else, however, taxes can take a huge bite out of the proverbial pie, especially if you are fortunate enough to occupy the upper rungs of the income ladder.
You should be wary of funds that habitually buy and sell 50 per cent or more of their portfolio.
• Comparing funds to benchmarks
Each fund has a different approach and goal. That’s why it’s important to know what you should compare it against to know if your portfolio manager is doing a good job.
Some popular benchmarks include the Dow Jones Industrial Average, the S&P 500, the Russell 2000, the Nasdaq Composite, and the S&P 400 Midcap. It's easy to search online to see what benchmarks funds are tied to.
You can then research reports on various funds and find out how they evaluate them, view historical data, and even get their analyst’s thoughts on the quality and talent of the portfolio management team.
• Ample diversification of assets
It’s vitally important that if you lack the ability to make judgment calls on a company’s intrinsic value, you spread your assets out among different companies, sectors, and industries.
Warren Buffett, known for concentrating his assets into a few key opportunities, has said that for those who know nothing about the markets, extreme diversification makes sense.
Simply owning four different mutual funds specializing in the financial sector, for example, is not diversification.
If something were to impact those funds on the scale of the real-estate collapse of the early 1990’s, your portfolio would be hit hard.
Risks of investing in international funds
• Currency risk
Investing in international funds faces major drawback called the currency volatility. Your investment is made in your home currency, which is then changed to a different currency, depending on the country in which it is invested.
Now if the foreign currency in which you have invested falls in value against the base currency, your profits will be eroded to extent of fall. Hence the gains you may have made through investments will be reduced.
• Constant monitoring
Political, social and economic aspects in different countries can impact mutual fund performances differently. So, investors must keep track of the market movement regularly.
Domestic and international politics or economic downturn can influence everything from interest rates to economic growth - all of these can affect the investment landscape.
There is always the risk of when value of investments may fall as well as rise. You may not get back the full amount that you originally invested.
Past performance is not a guide to future performance. There is no guarantee about the level of capital or income returns that will be generated.
• Taxation of international funds
This is a real dampener. Funds that invest in stocks abroad do not carry the advantage of equity investing. These are taxed as a debt fund.
If you hold them for over three years, long-term capital gains tax at the rate of 20 per cent (with the inflation indexation benefit) is applicable. For a holding period of less than 3 years, you’ll have to pay a short-term capital gains tax as per the income tax slab system.
For instance, hybrid global funds invest 65-70 per cent of their corpus in domestic companies and the remaining in overseas markets. Therefore, it makes the returns subject to long-term capital gains tax.
Key takeaway points to investing in overseas funds
So, to summarise here are some points to keep in mind when investing in international funds.
• If you wish to make use of international funds for your advantage, research thoroughly before investing as well as during the term of holding the investment.
• If you’re a beginner, follow the basic principles of investing in a mutual fund, read the offer document carefully and ask for clarifications, understand the investment objective of the fund and the risks it intends to take and analyse if these aspects are in sync with your investment strategy.
• Also, for region-specific funds, assess the feasibility of investing in those regions for the next few years. Similarly, for country-specific or commodity-specific funds.
• If you’re a pro-investor with a good understanding of domestic and global markets, then it is advised to go for a 10 per cent to 15 per cent allocation to foreign funds.
Researching international funds
Given that there are several international mutual fund options to choose from, you can use a number of tools to research on these funds.
Using websites of Lipper Leaders, Morningstar, Kiplinger Mutual Fund Finder, MAXfunds and FundReveal, you will come across performance data of various mutual funds and be able to compare historical NAV of these funds to relevant indices.
These research sites provide detailed information like performance history, expenses, investment objective, risk attributes, manager bio, and more. Each mutual fund research site has its distinguishing services and tools.