Which is the Best International Equity Mutual Fund in India?

We have seen that adding international (foreign) equity to the portfolio adds value.

Why?

A simple explanation is that such foreign stocks won’t be affected by ups and downs of the Indian economy or Indian stocks. After all, you wouldn’t expect Amazon stock price to fall sharply if the RBI raises repo rates in India or there is a negative surprise on Indian GDP numbers.

And if you are lucky, you may earn higher returns too (if the foreign stocks do better than Indian stocks). The utility can come in the form of lower portfolio volatility or higher returns or both. Hence, if you are building a long-term portfolio, you must consider exposure to foreign equities. Additionally, exposure to foreign assets provides protection against sharp rupee depreciation.

How do you invest in foreign stocks?

There are two ways:

1. Open an account with a US brokerage firm or invest directly in global stocks/index funds/ETFs. There are many options these days. You can open an account with Vested, Stockal, Interactive Brokers You will have to remit money under LRS (Liberalized remittance scheme) and then invest. There are remittance costs, TCS and US estate laws to take care of. This post from Shyam Sunder (FreeFloat) discusses all these aspects in great detail.
2. Invest in funds from Indian AMCs (and these AMCs will invest abroad on your behalf). While not the most cost-effective, this is a very simple way to invest in foreign equities. No operational or succession challenges. In this post, we will focus on these options from Indian AMCs in this post.

What international equity options do Indian AMCs offer?

There is no dearth of options. You just need to check out the list of funds on ValueResearch. There are funds to invest in US equities, European Equities, ASEAN, China and many more. Depending on your conviction, you can pick up an international equity fund. HDFC recently launched a HDFC Developed World Indexes fund that will split money across developed markets (US, Canada, Europe, Japan, Australia and a few other countries in Asia-Pacific). While this is not a recommendation, this shows the depth of choice you have.

I will mention the names of various schemes in the post. I have picked up the funds for analysis. Please don’t consider these as recommendations.

The Indian investors are warming up to the benefits of international investing (this could also be due to the super returns that US tech stocks have offered over the last decade). Therefore, you can expect AMCs to satiate the appetite. Expect more products in this space. Navi mutual fund plans to launch some interesting low-cost ideas in the space.

Many international funds have FoF structure

There are actively managed international equity mutual funds.

There are index funds and ETFs.

We have Fund of Funds (FoF) that invest in international equity ETFs and index funds

And we have FoFs that invests in actively managed funds.

Many of these international equity mutual funds work in Fund-of-funds (FoF) format. You invest in the FoF and the FoF invests in another actively or passive managed fund.

For instance, Franklin India Feeder US opportunities fund invests the money in Franklin US Opportunities fund.

DSP US Flexible equity fund invests your money in Black Rock Global Funds-US Flexible Equity fund.

Motilal Oswal Nasdaq 100 FoF invests in Motilal Oswal Nasdaq 100 ETF.

Kotak Nasdaq 100 FoF invests in iShares Nasdaq 100 UCITS ETF.

However, not all international equity funds are like that. ICICI Prudential US Bluechip Equity Funds invest in US stocks directly. Similarly, Motilal Oswal S&P 500 index fund tracks the S&P 500 index and holds the stocks directly.

In the FOF structure, there will be dual incidence of costs. Expense ratio of the FoF and the expense ratio of the underlying fund or ETF. So, don’t just focus on the expense ratio of the FoF. Look at the expense ratio of the underlying fund or ETF too.

Motilal Oswal Nasdaq FoF-Direct has expense ratio of 0.1 but the underlying ETF has an expense ratio of 0.5. Thus, the total cost is 0.6. If you invest in the regular variant of FoF, the total expense ratio will be higher.

Kotak Nasdaq 100 FoF-Direct has an expense ratio of 0.27. The underlying IShares Nasdaq 100 UCITS ETF has an expense ratio of 0.33. Thus, the total cost is 0.6 for the direct plan.

Franklin India Feeder US opportunities fund-Direct has an expense ratio of 0.52. Regular variant has an expense ratio of 1.56%. The underlying fund (Franklin US Opportunities Fund) has an expense ratio of 1.82%.  That makes total cost about 2.3% for direct variant and about 3.4% for regular variant.

Note: There is complication of withholding tax if the underlying ETFs/index funds are not domiciled in US. There is withholding tax of 25% (or as per tax treaty rates) on the dividend paid by stocks to foreign entities, also called non-resident aliens. For instance, since Motilal Nasdaq ETF is domiciled in India, the dividends paid will be subject to withholding tax. This will affect the performance of both the ETF and the FoF. Motilal Oswal S&P 500 index fund will also face this problem. The iShares Nasdaq 100 UCITS ETF (where Kotak Nasdaq FoF) is domiciled in the UK. So, the issue of withholding tax will be applicable there too.

How are international equity mutual funds taxed?

The international (foreign) equity funds are taxed like debt funds. Any capital gains resulting from sale of units before completion of 3 years are considered short term capital gains (STCG) and taxed at your slab rate.

If you sell after 3 years, the resulting gains shall be considered long term and taxed at 20% after adjusting for indexation.

Which is the Best International Equity Mutual Fund?

I will limit the analysis to the funds focussed on US equities.

While this is not the best approach, the US is more than 50% of the global market cap. Therefore, if you are trying to build a diversified equity portfolio, you must take exposure to US stocks. I may also be biased towards US stocks because US stocks have done very well over the past 10-12 year or so.

For comparison, I pick up the following funds/ETFs

1. Motilal Oswal Nasdaq 100 ETF (will use the day-end NAV of the ETF instead of the closing price)
2. Franklin India Feeder US Opportunities Fund
3. ICICI US Bluechip Fund
4. DSP US Flexible Equity Fund

Have chosen these funds because these funds are the oldest among the funds focussed solely on US equities.

We will compare the performance of these funds/ETF against US bellwether index (S&P 500) index. It is the market cap-based index and has 500 largest companies in the US. Will use the Net Total Return INR index (SP500NTR).  Net Total Return (NTR) index is different from Total Return (TR) index in the sense that it considers the impact of withholding tax on dividend reinvestments.

Since the funds quote their NAV/price in INR, we will use the INR variant of the index. Fortunately, S&P website provides for easy download of the data.

I know upfront that Nasdaq 100 index has done better compared to S&P 500 index over the last decade. However, this outperformance may not continue in the future. Moreover, Nasdaq 100 is a different index, and it is unfair to compare its performance against S&P500 index. Still, I have added the fund for comparison.

S&P 500 index NTR (INR): Rs 100 invested in January 2013 grows to 446.5 on September 30, 2021. CAGR of 18.68% p.a.

Motilal Oswal Nasdaq 100 ETF: Rs 720.4. CAGR of 25.36% p.a.

Franklin Feeder US Opportunities Fund: Rs 530.78. CAGR of 21.05% p.a.

DSP US Flexible Fund: Rs 398.62. CAGR of 17.15% p.a.

ICICI Prudential US Bluechip Equity Fund: 434.55. CAGR of 18.31% p.a.

Contrast this with the performance of Nifty 50 (PR) during the same period. Rs 100 invested in Nifty in January 2013 would have grown to only Rs 296 over the same period. CAGR of 13.23% p.a.

Therefore, all the international equity funds we discussed have done much better than Nifty 50. This does not mean that you sell your domestic equity funds and put all the money in US equity funds. The outperformance of US stocks may not continue in the future. We are exploring international equities to diversify the equity portfolio.

Coming back, Motilal Nasdaq 100 ETF is a clear winner, primarily due to the run-up in tech stocks.

DSP US Flexible Fund and ICICI Prudential US Bluechip fund have struggled to beat S&P 500 index over 8 years.

Franklin Feeder US opportunities Fund has done better than S&P 500 index. However, its benchmark of the underlying fund is Russell 3000 Growth index. And the underlying fund has underperformed the benchmark. You can check the details here.

You may call it my bias. When it comes to international equity funds, I would stick with passive funds.

On to the rolling returns.

Nothing unexpected here.

We do have a S&P 500 index fund, don’t we?

We do not have many index/ETF options for S&P 500 index. Motilal Oswal AMC had launched Motilal Oswal S&P 500 index fund, which opened for ongoing subscriptions on April 29, 2020.

A small problem with Motilal Oswal S&P500 index fund is that its NAV is delayed by a day. Let’s say S&P 500 falls by 2% on Monday. The corresponding fall/rise will reflect in Motilal S&P 500 index on Tuesday. Moreover, there can be days when US markets are open but Indian markets are closed. The cumulative impact of S&P 500 movement during Indian holidays will reflect in Motilal S&P 500 index fund only on the day the Indian markets open. This can cause a lot of confusion if we simply look at point-to-point returns. And I have seen such articles making wrong inferences.

To avoid any confusion, I have picked dates when S&P 500 index didn’t move much. May 5, 2020 and September 24, 2021. Note that the data is limited.

Rs 100 invested in S&P 500 TR INR on May 5, 2020 grows to 154.78 as on September 24, 2021. CAGR of 36.99%.

S&P 500 NTR INR: Rs. 153.73. CAGR of 36.32% p.a.

Motilal Oswal S&P 500 index fund: Rs 151.51. CAGR of 34.90%

Tracking error of about 2% against Total returns index (TR).

Tracking error of about 1.4% against Net total returns index (NTR).

Let’s also look at 1-year rolling returns to get a better sense of tracking error.

Average difference between S&P 500 TR INR and Motilal Oswal S&P 500 index fund (in 1-year rolling returns) is about 2.35% (we have only about 100 data points).

Average difference between S&P 500 NTR (INR) and Motilal Oswal S&P 500 index fund (in 1-year rolling returns) is about 1.73%.

Motilal Oswal S&P 500 index fund has an expense ratio of 0.5%. Then, there are remittance costs and delays, usual tracking challenges etc. Still, a tracking error of ~2% does not seem low.

If you were investing directly (buying S&P 500 index fund/ETF through a US broker), you would incur remittance costs to the tune of 1-5%-2%. However, that would be one-time, especially if you are a long-term investor.

Better to invest in S&P 500 index fund or Nasdaq 100 index fund?

This is complicated. If we consider these indices in isolation, S&P 500 index looks a better bet.

S&P 500 is more diversified while the Nasdaq 100 is technology heavy. Nasdaq 100 does not have energy companies or banks and financial services companies.

Thus, you can expect Nasdaq 100 to be more volatile than S&P 500. And it is.

I reproduce this tabulation from Motilal Oswal website (September 30 presentation on Nasdaq 100 FoF).

At the same, we are more concerned about diversifying our overall equity portfolio. Or the intent is to reduce volatility of the portfolio and NOT to pick up investments that are less volatile. Thus, we must focus on the correlation between the various investments in the portfolio.

I reproduce this table from a September 30 presentation from Motilal Oswal AMC.

You can see that the correlation of Nasdaq 100 with Nifty 50 is lower than correlation of S&P 500 with Nifty 50.

At the same time, the correlation between Nasdaq 100 and S&P 500 is quite high. And that is expected too since the two indices have a high overlap.

Thus, there is no need to complicate this.

Depending on your comfort, you can pick any of these indices for US equity indices for international (US) equity investments. Don’t just get carried away by the super returns that Nasdaq 100 has offered over the last 10-12 years. This can change quickly.

I prefer Nasdaq 100. I find Nasdaq 100 quite complementary to Indian stocks. Our indices are heavy on energy and BFSI companies, something Nasdaq does not have. And we are low on pure technology companies, the kind of companies Nasdaq 100 is very heavy on.

Which is the best Nasdaq 100 fund?

Assuming you want to invest in Nasdaq 100, how would you invest there?

I focus on investments domiciled in India.

In India, we currently have 4 options.

1. Motilal Oswal Nasdaq 100 ETF. Launched in 2011.
2. Motilal Oswal Nasdaq 100 FoF. Launched in 2018. Invests in (1)
3. Kotak Nasdaq 100 FoF. Launched in Feb 2021. Invests in iShares Nasdaq 100 UCITS ETF. Launched in Feb 2021.
4. ICICI Prudential Nasdaq 100 index fund (Recently launched. Too new to be considered)

Since all the above are passive funds, we are primarily concerned about the tracking error of these funds/ETFs. However, of the choices discussed above, only Motilal Nasdaq 100 ETF and FoF seem to have a reasonably long track record to perform any kind of tracking error analysis.

Motilal Oswal Nasdaq 100 ETF trades on Indian stock exchanges. Now, when the Indian markets are open, US markets are closed. Thus, there is no real time price data about the underlying constituents on Nasdaq. At what price do you place your buy or sell bid? Essentially, you trade in the vacuum. You can look at Nasdaq futures price and bid accordingly. However, it is still very complex. This can lead to deviation between the price and NAV of the ETF.

While the Motilal Nasdaq 100 ETF is a fine choice (as we shall see later), I find investing in Motilal Oswal Nasdaq 100 ETF a bit complicated.

Still, among our choice of funds, the Motilal Oswal Nasdaq 100 ETF has been around for the longest time. Thus, it is important to compare its performance against Nasdaq 100 TR INR.

I have compared the data since March 31, 2011.

Rs 100 invested in Nasdaq 100 TR INR on March 31, 2011 would have grown to 1,182. CAGR of 26.51%.

Rs 100 invested in Motilal Oswal Nasdaq 100 ETF on March 31, 2011 would have grown to 1,095. CAGR of 25.60%.

That’s a difference of 0.91% p.a. over 10 years. Given that the ETF has an expense ratio of 0.5, this error seems reasonable to me. Earlier, we checked that the tracking error in the S&P 500 index fund was ~2%. Quite high compared to Nasdaq 100 ETF. Clearly, Motilal Oswal AMC needs to do a better tracking job with S&P 500 index fund.

At the same time, the ride with Nasdaq 100 ETF has not been smooth. In 2018, there were stretches of period when the difference between the price and NAV of the ETF remained above 10%. You can see that in the Rs “100 grows to” chart above or the 1-year rolling return chart below. However, the deviation between the price and NAV is quite comfortable since Motilal AMC launched the FoF that invests in the Nasdaq 100 ETF.

Why?

Motilal Oswal Nasdaq100 FoF invests in Motilal Oswal Nasdaq 100 ETF. The NAV of FoF depends on the closing price (and not NAV) of the ETF. Therefore, it is extremely important for Motilal AMC to keep the difference low.

Motilal Oswal Nasdaq 100 FoF

The FoF was launched in December 2018. We compare the performance since January 2019.

Difficult to figure out from the above chart.

Rs 100 invested in Nasdaq 100 TR INR in January 2019 would have grown to 257.1 as on October 8, 2021. CAGR of 40.70%.

Motilal Nasdaq 100 ETF (closing price): Rs 253.2. CAGR of 39.93% p.a.

Motilal Oswal Nasdaq 100 FoF: Rs 249.8. CAGR of 39.25% p.a.

Motilal Oswal Nasdaq 100 ETF (NAV):  Rs 253.7. CAGR of 40.03%. This number is important as this indicates how well Motilal AMC is hugging the benchmark. Note that you can’t invest directly on ETF NAV.

Think this is a fine performance by Motilal AMC.

Kotak Nasdaq 100 FoF

The iShares Nasdaq 100 UCITS ETF (where Kotak Nasdaq FoF invests) is listed on the London stock exchange, which has an overlap with US market hours. Thus, when the ETF is being traded, the traders will have access to real-time NAV of the ETF and can place bids accordingly. Thus, you can expect the difference between NAV and price to be low. When NAV of Kotak Nasdaq FoF is calculated, the closing price (and not the NAV) of iShares Nasdaq 100 UCITS ETF will be considered.

The FoF was launched in February 2021. Hence, we do not have much price data.

As a proxy, I compared the performance of the underlying iShares Nasdaq 100 UCITS ETF with Nasdaq 100 TR (USD).

Over the past 5 years, the ETF has delivered 25.59% p.a.  Nasdaq 100 TR: 25.94% p.a.

Over the past 3 years, the iShares ETF has delivered 25.30% p.a. Nasdaq 100 TR: 25.52% p.a.

Hence, you can expect tracking error to be in the range of 25-40 bps. The ETF has an expense ratio of 0.33% p.a. With this, the tracking error is reasonable.

We ruled out Motilal Oswal Nasdaq 100 ETF earlier (not because it is a bad choice but because it is complicated for most of us). So, we are left with 2 FoFs.

Between Motilal Oswal Nasdaq 100 FoF and Kotak Nasdaq 100 FoF, which one do you choose?

Kotak Nasdaq 100 FoF does not really have much history. However, the underlying ETF (iShares Nasdaq 100 ETF) was launched in 2010. Therefore, we can compare the performance of Nasdaq Total Returns (TR) INR, Motilal ETF and iShares Nasdaq ETF.

We can go with the FoF where the underlying ETF hugs the Nasdaq 100 TR INR better.

A rolling returns comparison would have been a better choice but the data for iShares Nasdaq 100 ETF is not available for all the dates. Therefore, I chose to do a point-to-point returns comparison. Easy to see that iShares Nasdaq 100 ETF hugs the benchmark better.

The 3-year data point for the Motilal Nasdaq 100 ETF is a bit out of place. It is because, during 2018, the ETF price was at a sharp premium to the underlying NAV. Therefore, the number is a bit distorted.  However, even the 1-year return is out of place for Motilal ETF.

To me, it seems Kotak Nasdaq 100 FoF is a slightly superior product than Motilal Nasdaq 100 FoF. However, I do not yet understand the operational challenges, which may force me to revisit the choice.

For the sake of completion, I will compare the performance of Kotak Nasdaq 100 FoF against other choices.

You can see this is so confusing. I would rather rely on the performance of the underlying ETFs.

Where should you invest?

If the choice is limited to US stocks, I would suggest you take exposure to an S&P 500 index fund (or an ETF or a FoF that invests in the S&P 500 ETF or index fund) or a Nasdaq 100 index fund/ETF/FoF. Or it could be another diversified US stock market index.

You can choose between Nasdaq 100 and S&P 500 index funds/ETFs/FoFs based on your preference. I like Nasdaq 100 more since it complements Indian indices better. Pick up the option with low cost and low tracking error. If you want to pick up an FoF, consider expense ratio of the underlying fund too.

If you have conviction about a theme/sector in US markets, you can take exposure to such themes. However, you may not get such options if you are investing via Indian AMCs. Investing directly through Vested, Stockal, etc will offer you a much wider choice.

How are you building up your foreign equity exposure?

Let me know in the comments below.

Image Credit: Pixabay