Topic 2: Two mutual funds that can help offset the currency impact on goals
The rupee touched a low of 76.83 to the US dollar on 21 April and it is expected to remain weak on the back of the economic consequences of the Covid-19 pandemic. A weakening rupee directly affects certain expenses such an education or healthcare planned abroad or the purchase of gold for a specific event like a wedding. A depreciation in the rupee pushes up the cost, in rupee terms, while an appreciation brings it down. This can affect the value of these goals.
Investors saving for these goals can neither predict the direction of the rupee or the magnitude of the impact. Two mutual fund categories—international and gold funds—can help you hedge manage the impact of currency movements on the cost of these expenses. We tell you what these are and how they help.
International Funds
International funds are either actively managed and invest primarily in securities of foreign companies listed in foreign markets directly, or invest in international indices, such as the Nasdaq or S&P 500.There are some funds that act as feeder funds which invest in an identified mutual fund in the international market and then there are funds of funds that invest in units of international funds.
Since these mutual funds invest in foreign currency-denominated stocks, say, stocks listed on the US stock exchanges, they act as a hedge against currency movement for Indian investors.
If you are saving for the education of your children abroad, you may face a situation where you may need a larger corpus in rupee terms than what was budgeted for because of rupee depreciation. Accumulating the corpus in international funds can help offset this risk. When you need the money, you can redeem from international funds in rupees.
If the rupee has depreciated, the exchange rate will work in your favour as you will get more rupees in exchange of the dollars invested in the fund. The depreciation in the rupee against the US dollar has been to the extent of 3.5-4% per annum on an average over the long term and this augments the returns earned from an international fund in rupee terms. “For dollar-denominated expenses in the future, allocation to India-based US funds would help offset the currency fluctuation risks.
Gold funds
The domestic price of gold is a function of the prevalent international price and the exchange rate at which it is imported. A depreciation in the rupee pushes up the landed price of gold.
Typically, households buy gold jewellery over time with the intent of gifting them on the marriage of a child or for other purposes. However, changes in designs and preferences will mean that some value is lost when the jewellery is remade. A more efficient option for you is to accumulate units of gold funds or gold exchange-traded funds (ETFs) over time and redeem the units at the prevailing price of gold when it is required. The funds so realized can be used to buy and gift gold in the form preferred, without the issues related to purity, storage, insurance and others that come with holding physical gold.
The price of gold at which the units will be redeemed and the price at which the jewellery or other forms of physical gold will be purchased will both be the prevailing price of gold. So you will not face a price shock from currency movements or other demand and supply factors when you need to meet the expense.
For a rigid need for gold, the best way to accumulate is through paper gold such as gold funds and ETFsThe advantage of using an asset class like equity to meet the need if the goal is well into the future which may give the investor a better corpus and greater flexibility in how they choose to use the accumulated funds.
What you should do
Given the current turmoil in currency movements, gold prices as well as net asset values of international funds will see volatility. Investing periodically into these funds using systematic investment plans (SIPs) can help you take advantage of interim price movements and also bring down the cost of acquisition.
If you are not looking at meeting specific expenses, investing in the two funds will provide diversification benefits to the portfolio, since they have low correlation with traditional investments such as equity and debt. An exposure of around 15% to each asset class can give meaningful diversification benefits.
Investors saving for these goals can neither predict the direction of the rupee or the magnitude of the impact. Two mutual fund categories—international and gold funds—can help you hedge manage the impact of currency movements on the cost of these expenses. We tell you what these are and how they help.
International Funds
International funds are either actively managed and invest primarily in securities of foreign companies listed in foreign markets directly, or invest in international indices, such as the Nasdaq or S&P 500.There are some funds that act as feeder funds which invest in an identified mutual fund in the international market and then there are funds of funds that invest in units of international funds.
Since these mutual funds invest in foreign currency-denominated stocks, say, stocks listed on the US stock exchanges, they act as a hedge against currency movement for Indian investors.
If you are saving for the education of your children abroad, you may face a situation where you may need a larger corpus in rupee terms than what was budgeted for because of rupee depreciation. Accumulating the corpus in international funds can help offset this risk. When you need the money, you can redeem from international funds in rupees.
If the rupee has depreciated, the exchange rate will work in your favour as you will get more rupees in exchange of the dollars invested in the fund. The depreciation in the rupee against the US dollar has been to the extent of 3.5-4% per annum on an average over the long term and this augments the returns earned from an international fund in rupee terms. “For dollar-denominated expenses in the future, allocation to India-based US funds would help offset the currency fluctuation risks.
Gold funds
The domestic price of gold is a function of the prevalent international price and the exchange rate at which it is imported. A depreciation in the rupee pushes up the landed price of gold.
Typically, households buy gold jewellery over time with the intent of gifting them on the marriage of a child or for other purposes. However, changes in designs and preferences will mean that some value is lost when the jewellery is remade. A more efficient option for you is to accumulate units of gold funds or gold exchange-traded funds (ETFs) over time and redeem the units at the prevailing price of gold when it is required. The funds so realized can be used to buy and gift gold in the form preferred, without the issues related to purity, storage, insurance and others that come with holding physical gold.
The price of gold at which the units will be redeemed and the price at which the jewellery or other forms of physical gold will be purchased will both be the prevailing price of gold. So you will not face a price shock from currency movements or other demand and supply factors when you need to meet the expense.
For a rigid need for gold, the best way to accumulate is through paper gold such as gold funds and ETFsThe advantage of using an asset class like equity to meet the need if the goal is well into the future which may give the investor a better corpus and greater flexibility in how they choose to use the accumulated funds.
What you should do
Given the current turmoil in currency movements, gold prices as well as net asset values of international funds will see volatility. Investing periodically into these funds using systematic investment plans (SIPs) can help you take advantage of interim price movements and also bring down the cost of acquisition.
If you are not looking at meeting specific expenses, investing in the two funds will provide diversification benefits to the portfolio, since they have low correlation with traditional investments such as equity and debt. An exposure of around 15% to each asset class can give meaningful diversification benefits.