Mutual funds offer investors the opportunity to participate in the growth of some of the country's largest and most profitable companies. There is no dearth of choice here since hundreds of domestic equity funds promise exactly this. At times, even the best of the lot gets weighed down. The Indian economy has been facing some problems and the recent performance of domestic equity funds mirrors this. However, not all funds are suffering. Many international funds seem to be doing well in an otherwise despondent market. For instance, Motilal Oswal MOSt Shares Nasdaq-100 ETF has delivered returns of 45% in the past one year.

There are a few global funds being offered in the country, with Motilal Oswal joining the fray just over a year ago, while Franklin Templeton Investments launched a fund a few months ago. Does this imply that the investors who are disappointed with the local market should add a global fund in their portfolio? Let's find out.

It is about Investment diversification

Being a growing economy with a powerful domestic consumption engine, we are spoilt in terms of expected returns from our investments. There is hardly any other country that provides such opportunities for investors. This is why firm believers in the domestic growth story may not want to invest abroad.

However, this strategy is not so much about the returns that your domestic investments are earning, nor is it about seeking higher returns elsewhere. The sole purpose of venturing abroad is to bring an element of diversification to your existing portfolio. The Indian markets may even go through extended periods of flat returns. So, it's a good idea to have some investments that bear little correlation to the domestic market. Besides diversification, another benefit that these funds offer investors is access to unique investment opportunities that are not available in India. While the Indian economy derives strength from several quarters, there are some areas where it falls short, such as technology, agriculture, commodities and defence. Investors can tap these opportunities available in a foreign market.

Look out for

Global funds, much like their counterparts that are focused on domestic space, carry the usual risks related to the market, business, etc. However, there are additional dangers, the first being the risk of the unknown. There is a variety of factors, such as geopolitical and socioeconomic, that is unique to each country or region that can influence their performance. It is important that investors get a hang of such regional issues before investing abroad.

International funds also carry a currency risk. Though your investment is in rupee terms, you have exposure to foreign currency assets (the rupee is first converted into dollar and then into the local currency for investing abroad). This may or may not work in your favour. The sharp depreciation in the rupee against the dollar (more than 20%) has contributed to the rise in the NAVs of several funds in rupee terms. When you invest for only a short span of time, this can have a big impact on your returns. However, currency movements will have little impact when the investment is made for a longer period of time.

The options

If you are convinced about the benefits of having international exposure, follow the mutual fund route. International funds come in many flavours and each has its own set of advantages. For instance, some offer a region- or country-specific exposure and others offer a thematic exposure. Apart from the investment focus, global funds vary in terms of their structure. There are those that invest abroad directly and those that do so indirectly through underlying funds. The former category consists of funds that do not rely on an offshore fund manager and make investment decisions on their own, that is, a local fund manager handles the portfolio. Some such funds available currently are the Birla Sun Life International Equity Plan A, Tata Growing Economies Infrastructure Plan A and ICICI Prudential US Bluechip Equity. While these are actively managed, the Motilal Oswal Nasdaq-100 and Goldman Sachs Hang Seng BeES are the only exchange traded funds (ETFs) among international funds, investing passively in the same stocks comprising the USbased Nasdaq index and Hong Kongbased Hang Seng, respectively.
The other category of funds-those that invest abroad indirectly-operate either as feeder funds (those that pool in money from here and transfer it to the parent fund managed offshore) or pure fund of funds (those that invest the money in a basket of offshore funds).

The feeder fund route - According to this route, your scheme is in the hands of a fund manager more in tune with that market.

All such international funds are treated as non-equity funds under taxation rules and attract debt taxation, unlike equity investments that are tax-free if sold after one year of investment. However, this means you can claim indexation benefits in the year of sale (20% with indexation and 10% without indexation).

Domestic funds are the first choice

International funds can play an important part in your portfolio as they widen the scope of diversification. However, the investment should be made not because it is the right time to do so or because the Indian equities are underperforming, but because it will lend a balance to your domestic investments in the long run. Venture out purely for the benefit of diversification rather than for higher returns. You need to stay invested in such a fund across market cycles, and not seek short-term opportunities based on any prevailing global or domestic economic scenarios.

Domestic funds continue to be the best vehicle to generate wealth over the long term no matter what the current situation might lead you to believe. The right mix of a few such diversified equity funds should form the core of your portfolio, while a suitable international fund can, at best, supplement your core holdings.