Derivative Funds

Derivative Funds

The suitability of any fund depends upon its objective. In case of derivative funds also, it will depend upon how they intend to use derivative instruments. For example, there are a few arbitrage funds which try to capitalise upon the mis-pricing between the spot and futures prices of a particular stock. Therefore, they use derivatives extensively in their portfolios but their positions are always hedged. A simple example of hedging would be to buy a particular stock and sell its future contract. Such an off-setting position would insulate the investment from market fluctuations. However, hedging often caps both the upside as well as the downside potential, making it a low risk-low return investment. Such a risk-return profile makes such funds comparable with income funds, and hence are suitable for investors who are looking for moderate returns with lower risk. Benchmark Derivative and JM Equity & Derivative are two such funds which have generated returns of 7.30 and 6.23 per cent respectively in the last one year.

In contrast to the above strategy, an un-hedged exposure to certain derivative instruments can be quite risky. Therefore, any fund with the objective of generating returns by taking unhedged positions in the derivatives may have a potential to generate higher returns than a diversified equity fund but will also be relatively more risky. Recently, Reliance Equity Fund has been launched which would seek to use derivatives more actively. But it is a new fund and right now nothing much can be said about it.

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Sumit K. Gupta
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Self Thought: The only Im-mortal thing in this world is DEATH. Everything else dies one day.

Investing Abroad !!!

On Investing Abroad

Once upon a time, it used to be a truism that Indians were crazy about everything foreign, or phoren, as it used to be spelled. Nowadays the distinction between desi and phoren is blurred since you can legitimately buy Indian-made foreign goods. However, the age of foreign investing is just about beginning. In many ways, the increasingly permissive rules about individuals investing in foreign companies through mutual funds are a watershed in the liberalization of the Indian economy. After all, the fact that capital couldn't flow abroad was a cornerstone of the old controlled economy. Except that no one seems to care. The response from investors has been noticeable mainly for not being there. In Budget 2006, the Finance Minister has raised the limit for total investments abroad from a billion dollars to two billion dollars yet this appears to be a meaningless gesture since the actual investments have been a tiny fraction of even the older, lower limit. In the two years since foreign investments through mutual funds have been permitted, just one fund has been launched that invests in foreign equities and that fund currently has an utterly irrelevant 13 crore rupees invested in it. That's about 0.3 per cent of the permitted limit of 1 billion dollars. However, I don't think this tiny number is an indicator of the future importance of investing abroad. Since the time that investing abroad has been permitted, the Indian stock markets have been doing better-much better-than most other markets abroad. As a result, Indian investors aren't really interested in investing abroad. Therefore, the actual future relevance of foreign investing will be known only when the markets turn. Think of a situation when the Indian stock markets are doing badly. And please don't tell me that in this globalised world everything moves in tandem, take a look at our cover story in this issue. If the Indian markets are doing badly and other markets are doing well, then I expect these two billion dollars to be exhausted overnight. Fund companies will be hawking country or region specific funds and investors will probably be clamouring for 'allotment' since there will be an upper limit for the amount of money that could be invested. If I peek into my crystal ball, I can foresee situations where people are buying and selling ('informally', and at a premium) such future products like a SBI Magnum US Tech fund or a Prudential-ICICI China Fund. Does this sound like wild speculation? No. I think this sort of a thing is almost inevitable. And when this happens I doubt whether the government will really bother to hold the limit. After all, investing abroad through this route can hardly be called capital account convertibility. That's because the money you invest abroad has to be eventually redeemed back through the same route in rupees. So if global markets are booming and ten billion dollars flow out, it will probably come back as eleven billion. Also, at some points when AMCs need to look at this type of fund seriously, they may well find out that their foreign investing products don't need to be exclusively foreign. I, for one, would welcome if some top-performing Indian funds could amend their offer documents and say that they could allocate investments abroad if market conditions justified it. All in all, it sounds like a very tax-efficient way to shift to a better-performing market when the need arises. One thing is certain. Whether these things happen next year or next decade, it's going to be a whole new world for Indian investors.

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Sumit K. Gupta
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Self Thought: The only Im-mortal thing in this world is DEATH. Everything else dies one day.