When it comes to choosing which Mutual Fund to invest in, there are a number of parameters based on which people make decisions. One of the most prevalent , even though unscientific parameters is Historical Returns. So assuming that you have to decide one mutual fund out of below two funds - based on last 5 year returns - which one will you choose?
Fund Name
|
Five Years Annualized Returns
|
Pictet Water P USD Fund
|
13.79%
|
Birla Sun Life Frontline Equity Fund (Regular Plan) - G
|
18.39%
|
*Performance as on 10th Sep’16. Source Morningstar.co.uk and moneycontrol.com
Please note that Pictet Water P USD is a $ (USD) denominated fund while Birla Sun Life Equity Fund is denominated in Indian Rupee (INR).
Needless to say you will choose Birla Sun Life Frontline Equity Fund (Regular Plan) - G based on its performance which is around 5% better than that of Pictet Water P USD Fund. Now if I tell you that 5 years back US Dollar was trading at 47.80 against Indian Rupee while today’s exchange rate is 66.59, will that bring any change of heart to you? If this rate fluctuation doesn't ring any bells in your mind, read the below analysis.
Let's assume that 5 years back you had 10,00,000 INR investible surplus and you had invested 5,00,000 each in the above two funds.So lets evaluate both funds’ performance one by one.
First let's analyse Pictet Water P USD Fund. As it is denominated in USD , so we can invest in it in USD only. We are assuming a level of 47.80 (which was recorded on 13th Sep, 2011) of INR against USD for exchange rate five years back. That means we invested $ 10460.25 in it five years back. At a return rate of 13.79% growth for last five years , this investment should grow to a value of $ 19955.5 in today’s (10 Sep’2016) date.
Now let's analyse Birla Sun Life Frontline Equity Fund (Regular Plan) - G in a similar manner. As it is denominated in INR so 500000 INR invested five years back growing at a rate of 18.39% for five years , will grow to INR 1162907 in today's date.
So 500000 INR invested in each of them 5 years back grows to $ 19955.5 (Pictet Water P USD Fund) and INR 1162907 (Birla Sun Life Frontline Equity Fund) in today’s date. To compare them on a level ground we should convert both of them in same denomination. Let’s convert both of them to INR. So at today (10th Sep’2016)’s exchange rate of 66.95, Pictet Water P USD Fund’s corpus is equivalent to INR 1336021, which is 14.68% more than Birla Sun Life Frontline Equity Fund’s corpus of INR 1162907.
What the above case study means is that foreign exchange fluctuations can bring substantial gains to your portfolio even if underlying assets (mutual funds in above case) have lower returns per se. The implicit message in the above case study was that INR has depreciated by more than 6% (compounded ) against USD per year for last five year. So a very crude form of thumb rule means that at same level of returns in respective currencies, USD denominated returns will beat INR denominated returns by 6%.
In India we resort to diversification in our portfolio at asset class level only , i.e. taking exposure to different kinds of Mutual Funds, Fixed Deposits , Small Saving Schemes etc. But geography and currency diversification hardly make their presence felt. Unfortunately very few options are available in India for taking global and currency diversification, that too with constraints like unfavorable tax treatment and large amount of initial investment. Still a smart and shrewd investor should always be on look out for those channels which can help in bringing currency and geographical diversification to your portfolio.
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