Should You Opt For Offshore Funds to Reduce Portfolio Risk?

Jun 02, 2020

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The pandemic crisis has wrecked havoc on the equity market. Emerging economies like India have been the worst hit due to the pandemic related disruption which led to foreign investors pulling out money. In March alone FPIs pulled out Rs 61,972.8 crore from the Indian equity market.

Amid this negative sentiment and high volatility, mutual funds across categories registered steep falls. This severely dragged down the long term returns of equity mutual funds.

Meanwhile, foreign investors found shelter in safe havens. Accordingly, developed economies such as USA and Japan witnessed spike in equity returns.

US stock index S&P 500 and Japan's Nikkei 225 index rose 10.6% and 6.2%, respectively in the last 1 year. China where the coronavirus originated had almost flat returns with a negative bias during the period. COVID-19 posed as a double whammy to UK's FTSE 100 which had been dealing with Brexit related fallout.

Whereas, Indian economy which was grappling with slowdown in demand took further hit amid the virus outbreak which lead to Sensex tumbling around 18% in the last 1 year.

[Read: Should You Stop SIPs Amid Coronavirus Outbreak and Market Fall?]

Table 1: How the pandemic has impacted the global indices

Absolute (%) CAGR (%)
Benchmark 1 Month 3 Months 6 Months 1 Year 3 Years 5 Years
S&P 500 4.53 3.05 -3.08 10.62 8.08 7.63
Nikkei 225 8.34 3.48 -6.08 6.20 3.65 1.25
Shanghai Composite -0.27 -0.97 -0.68 -1.60 -2.92 -9.15
FTSE 100 2.97 -7.66 -17.29 -15.15 -6.86 -2.74
S&P BSE SENSEX -3.84 -15.34 -20.52 -18.36 1.35 3.10
Returns are point to point and in percentage. Regular Plan - Growth Option considered
Data as on May 29, 2020
(Source: ACE MF)

The above table highlights that that diversification across geographical boundaries can help mitigate portfolio risk. Investing via mutual funds is a simple and convenient way to take exposure in stocks of global giants.

Image Source: photo created by xb100 - www.freepik.com

Benefits of investing in international markets through Mutual Funds are:

  1. You do not have to go through the difficult task of selecting stocks on your own because mutual fund is a simple way to invest in international markets.

  2. Get exposure to stocks of global corporation giants like Apple, Google, Amazon, etc.

  3. Higher returns potential when other economies grow at a faster pace than the domestic economy,

  4. Investing in a particular opportunity only available in offshore markets.

  5. Can help hedge rising foreign expenses such as foreign education and travel

The top performing offshore fund generated a whopping 38.7% returns in the last one year. Most of the top performing offshore funds are US-focused.

Table 2: Top Performing offshore funds

Absolute (%) CAGR (%)
Benchmark 1 Month 3 Months 6 Months 1 Year 3 Years 5 Years
Motilal Oswal Nasdaq 100 FOF 5.80 16.35 17.80 38.67 NA NA
Edelweiss Gr China Equity Off-Shore Fund 0.64 8.51 14.39 38.59 16.79 9.12
Franklin India Feeder - Franklin U.S. Opportunities Fund 8.29 17.20 16.91 32.39 21.16 14.08
PGIM India Global Equity Opp Fund 10.89 15.50 18.42 31.21 19.47 7.49
ICICI Pru US Bluechip Equity Fund 1.96 8.95 3.54 25.11 16.80 12.66
Category Average - Offshore Funds 4.27 1.56 -3.87 7.64 5.92 3.54
Category Average - Diversified Equity Funds -0.18 -17.08 -18.22 -17.33 -2.52 2.63
Returns are point to point and in percentage. Regular Plan - Growth Option considered
Data as on May 29, 2020
(Source: ACE MF)

What has helped these funds rise against turbulence?

The funds constitute some of the best performing and popular US stocks such as Amazon, Facebook, Microsoft, Zoom, Netflix, Alphabet. Most of these belong to technology sector. The lockdown has proved beneficial for such companies due to surge in demand for their services.

Will the strong performance sustain?

Just like every investment, investment in offshore fund carries certain risk. Changes in government regulations and policies relating to companies, industries, investments; geopolitical events, economic growth and so on impacts the attractiveness of investment. Moreover, as International investments have exposure to foreign currency assets, fluctuations in exchange rate can impact your returns.

The current global climate is full of uncertainties due to coronavirus-related disruptions. Increased political and military tensions in various parts of the world may add to the pain.

Here are some of the factors that may keep global equities on the edge in the coming months:

  1. Global recession

    The ongoing coronavirus crisis has prompted a recessionary phase in many parts of the world (including the developed economies). Some experts fear the economic impact due to the pandemic could be worse than the global financial crisis of 2008. Even though lockdown restrictions have eased in many countries and governments have announced relief packages the recovery would be slow and bumpy process. Unemployment levels are expected to rise significantly which would weigh heavily on demand. A weak economic outlook does not bode well for financial markets.

    [Read: Can a 'Hindu Growth Rate' Help You Earn Decent Mutual Fund Returns?]

  2. US-China trade war

    In the pre-COVID era US and China were very close to closing phase-1 of trade deal after months of tariff disputes. The deal involved China boosting US imports and strengthening of intellectual property rules. Now in the aftermath of the pandemic US has warned that it would cut off entire relationship with China for its alleged role in covering up the initial stages of the virus outbreak. Meanwhile, Chinese President Xi Jinping announced he is preparing his troops for war, potentially against the US. If the spat for the superpower tag between the two countries intensifies it could induce sell-off in global markets.

    Apart from this, containment of virus spread, Brexit negotiations, social unrest in some countries such as Hong Kong, oil price and demand, corporate profitability will set course for global equity market and thereby the performance of offshore funds.

What should investors do?

Offshore funds can form a part of your portfolio if it provides diversification. Remember, beyond a point diversification can become counterproductive and fail to generate higher returns.

If you are an Indian investor, it will make more sense to invest in economies like the US, which has lower co-relation with the Indian market, rather than in emerging economies whose market/s movement is frequently parallel with Indian markets. But beware of the risks involved.

If your existing portfolio is well in place, offshore funds need not form a part of your portfolio. You may however, allocate a small portion towards offshore funds to diversify across geographies.

I believe that if you have a long term investment horizon of at least 5-7 years, the current domestic market condition provides a valuable opportunity to create wealth at a better margin of safety.

To get the optimum benefit of diversification, opt for the 'Core & Satellite' approach to investing in equity mutual funds.

The term 'Core' refers to the more stable, long-term holdings of the portfolio; while the term 'Satellite' applies to the strategic portion that would help push up the overall returns of the portfolio, across market conditions.

The 'Core' holdings should form a major portion (around 65-70%) of the mutual fund portfolio and ideally should consist of a large-cap fund, multi-cap fund, and a value style fund.

The rest, say around 30-35%, can be 'Satellite' holdings consisting of a mid-cap fundlarge & mid-cap fund and an aggressive hybrid fund. If as an investor you are willing to take the risk, a small portion could be allocated to small-cap as well in the satellite holding.

Even though the markets are expected to remain volatile the 'Core & Satellite' approach can help limit the downside risk.

Here are the key benefits of the 'Core & Satellite' approach

  1. Optimum diversification across market capitalisations and investment styles;

  2. Reduces to need to churn the portfolio constantly;

  3. Reduces the risk to the portfolio;

  4. You potentially gain from a variety of investment strategies;

  5. Aims to create wealth limiting the downside risk;

  6. Hold the potential to outperform the market

Investing based on your personalized asset allocation plan is the true essence of successful investing. A healthy portfolio is the one that takes calculated exposure across different asset classes so that if one asset class fails to generate lucrative returns other asset classes can protect your portfolio from financial loss.

If you wish to invest in a readymade portfolio of top recommended equity mutual funds based on the 'Core & Satellite' approach to investing, I recommend that you subscribe to PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025 (2020 Edition)".

 

Warm Regards,
Divya Grover
Research Analyst

 

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