Financial Daily from THE HINDU group of publications
Sunday, Apr 14, 2002

Investment World
Port Info

Group Sites

Investment World - Insight
Columns - Taking count
Markets - Mutual Funds

Investing abroad: Sensible restriction on mutual funds

Suresh Krishnamurthy

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
Tea — pale and watery

Tea: Positive policy changes
So, what's for tea?
Coffee: Brewing still
`We want to deliver a better mix' -- — Mr P. T. Siganporia, Deputy Managing Director, Tata Tea
Uneven tax field for domestic manufacture
Mastershare 86: Hold/Avoid fresh exposures
Sundaram Bond Saver: Invest
UTI Services Fund: Cut exposures and book profits
Pioneer ITI FMCG: Pare exposures
MIP '97: Take cash, avoid rollover
Focussing on theme funds
Warrants from UTI
Wockhardt: Buy
Infosys: Sell now and buy at lower levels
MphasiS BFL: Sell/Buy on declines
Unichem Lab: Book profits early
Swaraj Mazda: Hold
TNPL: Hold
US tightens visa rules
Transit visa on Air France
Medium-size software companies -- Exaggerated valuations
Frontline software companies -- Lessons from the returns
Endowment assurance policies -- Rest assured, with caution
Techs keep Sensex in positive zone
IPCL moves up on divestment hopes
Positive trend in Sterlite Optical
Nasdaq at crucial juncture
Bonds carry downside bias
Volumes decline on bourses
Interest wanes on index puts
Reliance Industries remains active
Options help guide
Futures guide
Revolve with Amex
Krishna Bhagya Jala Nigam: Invest (Medium-to-high risk)
TVS Srichakra: On a smooth ride
Income received outside India
Two-wheeler market: Gathering speed
UTI's assured return schemes -- Hardly reassuring?
Investing abroad: Sensible restriction on mutual funds
Does investing abroad generate higher returns?
It Adds Up!

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