The Hindu Business Line : No advantage, global investing

UTI Mutual Fund proposes to launch a fund that will invest in stocks constituting the Dow Jones Global Titans 50. This proposal brings to the fore the broader issue of Indian investors taking exposure in global stocks. Typically, emerging markets have delivered higher returns than their developed counterparts. According to statistics available on the Morgan Stanley Capital International (MSCI) Web site, emerging markets returned 21 per cent over a three-year period while G-7 countries returned under 2 per cent. Specifically, Indian stocks generated 26 per cent returns compared to less than 2 per cent in US stocks. Why, then, are Indian fund-houses queuing up to launch global funds?

Those with an academic bent of mind may cite portfolio diversification as the primary reason for investment in global markets. But given the associated risks, benefits of global investing are not all that apparent. Investors may, perhaps, be better off with exposure in the domestic market unless portfolio managers exhibit high security selection skills in the global market.

Portfolio diversification: Typical studies in this area have concluded that diversifying across global markets enhances return for the same level of risk or reduces risk for the same level of return. This essentially means that a portfolio manager can improve his risk-return matrix on the Markowitcz mean-variance efficient frontier.

Financial literature in this area, however, does not normally consider changing correlations across global markets. Portfolio diversification fails just when it is needed the most. Specialised studies have shown that correlations across global markets increase dramatically when tail events occur. That is, events that occur very rarely but severely hurt asset values when they do. The 9/11 attack in the US, for instance, caused a global meltdown as did the Gulf War in 1992.

Of course, proponents of global investing would argue that since tail events are rare, such portfolio diversification would pay off handsomely under normal conditions. This argument may not hold much water. The reason is not far to seek. Developed markets experience stable and low economic growth rate. Since stock market returns tend to mimic the underlying economic activity, absolute returns in the developed markets are bound to be lower. Besides, there is the problem of currency risk. If fund-houses hire currency overlay managers to manage this risk, associated costs will increase.

Restrictive regulations: Investing in other emerging markets may be worthwhile. Portfolio managers need to, however, cope with high political, currency and market risks. Security selection, hence, plays an important role in the portfolio construction process. Domestic portfolio managers may not be well equipped to pick stocks in the emerging markets. Buying reports from sell-side equity firms in those markets will only increase costs and therefore, the portfolio management fees. It is moot if the portfolio returns can be enhanced after adjusting for such risks and additional costs.

In any case, existing regulations do not permit fund-houses to invest in stocks in all markets. Funds can invest in only those companies that hold at least 10 per cent stake in a company listed on an Indian stock exchange. This restrictive policy forces fund-houses to primarily take exposure in companies that are parents of MNCs in India. The portfolio manager is, hence, robbed off the security selection process. That the Principal Opportunities Fund has generated less than 4 per cent return is merely a reflection of the restrictive investment policies and the additional risks that the portfolio is exposed to.

Striking a balance: This does not, however, mean that investors should not look to building a global portfolio. Such an exposure may be best served through hedge funds. The reason is that such funds largely adopt market neutral strategies and strive to enhance portfolio alpha through superior security selection. SEBI should consider regulatory changes that will enable fund-houses in India to take exposures in hedge funds abroad. Perhaps, then, Indian investors can reap the real benefits of diversification.

(Feedback can be sent to bvenky@thehindu.co.in)

More Stories on : Mutual Funds | Insight | Mark To Market | Investments

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Save the cotton

Significance of China's economy to global growth

Mid-term appraisal of Plan targets — An opportunity for experts to get real

No advantage, global investing

Petro-product prices — Soft-pedalling can hurt govt hard

Getting the cream for civil services

Derrida's derring-do

Affable Ambassador

Planning Commission