Financial Daily from THE HINDU group of publications
Sunday, Apr 14, 2002
Columns - Taking count
Markets - Mutual Funds
Investing abroad: Sensible restriction on mutual funds
THE restriction of 4 per cent of net assets imposed on investments abroad by debt funds is a sensible move by SEBI. As part of the efforts to relax capital account controls, the Finance Minister, Mr Yashwant Sinha, announced in the Budget that mutual funds can invest in rated overseas debt securities. However, there are several complicated issues involved in such investments.
As such, it was in the fitness of things that SEBI had restricted such investments. Fund managers can experiment with the 4 per cent limit and depending on their success, the limit can be enhanced.
Investments in overseas securities are not likely to lead to better returns. Interest rates in the US, Euro zone and in the UK where fund managers are likely to be comfortable investing are lower than what they are in India. Still, investing in overseas securities has its advantages. At present, a debt portfolio is sensitive to interest rate changes in India. If a portion of the portfolio were invested abroad, then a portion of the portfolio would be sensitive to interest rate changes of another country. If the interest rate movements in the two countries are not correlated or if the correlation were lower, then an adverse interest rate movement in one country will not affect the entire portfolio. Thus, the sensitivity of the portfolio to interest rate risk can be reduced.
For instance, when US' federal funds rate barometer of interest rate movements in the US fell from a high of 5.75 per cent to 1.75 per cent, interest rates in India too declined. However, there was a sea of difference. Long-term interest rates in the US did not fall as sharply as short-term rates. In contrast, long-term interest rates in India fell much more sharply, compared to short-term rates.
Importantly, interest rates in the euro zone and the UK remained relatively sticky during the same period. In short, interest rate movements across these currency zones did not display much correlation, suggesting that investments made broad can produce benefits from diversification. However, investments in overseas securities are complicated by the currency factor. In making an investment within India, the fund manager has to look at only the characteristics of the investment. In the case of an investment made in overseas securities, the fund manager has to look at not only the characteristics of the instrument. The prospective currency movements which will also affect returns need to be considered.
For instance, if the instrument generates a yield to maturity of 5 per cent and the rupee has depreciated 3 per cent during the period, the total return is 8 per cent in rupee terms for the investor. However, if the rupee appreciates during the period, then returns would be reduced. Again, returns would vary depending on whether the currency position was hedged by the fund manager or not.
Now, while investors have information to evaluate the investment management record of the fund manager, we do not know about his expertise in currency management. This applies equally to a situation where a new manager is appointed to take care of currency management. It is in this backdrop that a 4 per cent limit appears quite sensible. Indeed, investors can expect the asset management company to put in place proper risk control measures. Still, a cautious approach in the short-to-medium term is necessary to evaluate the fund manager's skills and the benefits from investing abroad.
Only when the limits are raised and when interest rates in India decline to levels on a par with developed countries, will the Indian investor get the benefits from investing in overseas securities. For the moment, it is only time for a little experimentation one that would hopefully lead to better investing times.
Send this article to Friends by E-Mail
Stories in this Section
The Hindu Group: Home | About Us | Copyright | Archives | Contacts | Subscription
Group Sites: The Hindu | Business Line | The Sportstar | Frontline | Home |
Copyright © 2002, The
Hindu Business Line. Republication or redissemination of the contents of
this screen are expressly prohibited without the written consent of
The Hindu Business Line