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Citrus Analysis: Bet on the US, ICICI Pru’s US Blue-chip Equity Fund
Tue, Jun 26, 2012
Source : Shoaib Zaman, Citrus Interactive

If you ask your financial planner, he will tell you that all your long-term portfolios (retirement and child’s education) should have an exposure of about 15-20 per cent (of the equity portion) to international equities. This international exposure should be split between a developed market and an emerging market. Among developed markets, what better option can you get than the US (notwithstanding its recent travails) -- the world’s largest economy with the deepest capital market? So far Indian investors had two options for investing in the US: Motilal Oswal’s MOSt Shares NASDAQ-100 ETF (a passive fund) and FT India Feeder Franklin US Opportunities (a feeder fund). With the launch of ICICI Prudential’s new fund offer (NFO), US Blue-chip Equity Fund, Indian investors now have a third, differentiated option for investing in the US market.

Nature of the fund

ICICI Pru’s US Blue-chip Equity Fund is an open-ended actively managed equity fund. It will be directly managed by Indian fund managers and is not a feeder fund. It will invest in the equity and equity-related securities listed on the New York Stock Exchange and the Nasdaq. The fund will invest in blue-chip stocks and is benchmarked against the S&P 500 index (a market cap-weighted index of the 500 biggest stocks, which is weighted towards large-cap stocks). The fund will have a portfolio of around 25-40 stocks. It will follow the fund house’s growth-at-reasonable-price (GARP) approach to investing.

Investing in the US: an idea whose time has come

There are many good reasons why Indian investors should have an exposure to the US market:  

Low correlation. According to Sankaran Naren, chief investment officer-equity, ICICI Prudential Mutual Fund, “Diversification is meaningful only if you add another asset class which behaves very differently from the existing asset class in your portfolio. The US market fits the bill.” Over different time horizons (one-year, three-year, five-year and 10-year), the correlation between the Nifty and the S&P 500 has been found to be between 0.23 and 0.30. The low correlation between the two markets combined with currency diversification does have the potential to benefit Indian investors’ portfolios.

Size and depth. The US is the world’s largest economy: US GDP is $15 trillion (compared to India’s $1.7 trillion) and it accounts for 21.67 per cent of total world GDP. The US also has the world’s largest capital market: listed companies in the US account for 33.29 per cent of world market capitalisation (compared to India’s 2.26 per cent). Given the size of the US economy and the depth of its capital market, no reasonably large-sized and long-tenure Indian portfolio can afford not to have an exposure to the US market.

Many of the biggest US companies today earn a substantial portion of their revenues and profits from markets across the globe. By investing in this fund, Indian investors will get not just US but global exposure.

Variety and novelty. By investing in the US market, the Indian investor will also get exposure to industries that don’t have a significant presence and scale in the Indian capital market: defence, aerospace, semiconductor, toys, Internet and e-commerce services.

US Blue-chip Fund’s strategy

Many investors are likely to pose the question: why invest in a US fund from ICICI Pru when the fund house does not have any particular expertise in the US market?

In the past, the fund house has run an Indo-Asia Fund (which invests 35 per cent of its corpus in other Asian markets) and has made a success of it. This fund is currently rated five-star by rating agencies.

Nonetheless, the lack of experience vis-à-vis the US market is an issue. To overcome it, the fund house has tied up with Morningstar Equity Research Services. The latter, a respected name in equity research, will lend its research expertise to ICICI Pru.

Morningstar publishes what is known as a wide-moat index (an index comprising companies that have competitive advantages over rivals). ICICI’s fund portfolio will replicate a significant portion of that index in terms of weightage and names.

However, the fund has a few additional filters of its own. Only those stocks from the index that have a market cap of at least $4 billion will be added to the fund’s portfolio. In addition, the fund managers will also have the freedom to pick stocks from outside the wide-moat index.

You could call this an index-plus-plus strategy. Typically index-plus funds stick to stocks within the index but play around with their weightages. Here, the fund manager will have far more leeway.

All in all, this is a strategy that could work for ICICI Pru.

Outsourcing research: a sound idea?

Many investors we spoke to also expressed concern about the outsourcing of equity research to a third party. In our view, this is not a big concern. Even in domestic fund management, a lot of dependence on third-party research exists. Fund managers use such research and then decide which stocks to pick and which to reject. Thus, ICICI Pru’s strategy in the international market is not dramatically different from the practice in the domestic fund management space.

Of course, it would have been better if it had a fund manager who was an expert in the US market. In that respect, Templeton’s feeder fund has an advantage. The bottomline, however, is which fund turns in a better performance in future.

Risks inherent in an international fund

Most Indian investors have very little exposure to international funds in their portfolios. It is an idea that has yet to gather widespread currency. The danger then is that if ICICI’s fund doesn't gather a meaningful corpus, then the fund may not get the degree of attention it deserves. Here again a feeder fund has an advantage. Since it already has a large corpus, there is no possibility of it suffering from neglect. This is a potential danger that investors should watch out for.

Another risk arises from investors’ home bias and their impatience vis-à-vis foreign funds. If a fund in the domestic market underperforms, Indian investors are likely to give it a longer rope. But they may be hastier in pulling the trigger on a foreign fund. Of course, this is an issue that all three US funds will have to contend with.

Another potential risk arises from currency movement. This again is not as big a risk as it is made out to be because of the nature of this fund. Many of the businesses that the ICICI Pru fund will invest in are multi-currency (MNC) businesses. Over the long-term, the uncorrelated movements of different currencies will end up reducing the overall currency risk of such a fund.

What should you do?

The Indian investor now has three options for investing in the US market. Which one should he go with?

The NASDAQ index is weighted heavily in favour of technology stocks. It comprises both older technology companies such as Cisco, Intel and Microsoft and newer ones such as Google. It is an index that is tilted towards new and growing businesses.

The S&P 500 index, to which the ICICI fund is benchmarked, offers a diversified representation of large-cap US stocks.

The Templeton feeder fund is benchmarked against the Russell 3,000 index. This is a total-market index that includes smaller stocks.

Our suggestion is that currently you should not try to build your US exposure through a single fund. All the three funds are different, so there is merit in looking at all three.

First, give 50 per cent exposure to a passive fund. Hence, Motilal Oswal’s NASDAQ ETF should be your first choice. It is a low-cost fund, and it offers you exposure to a set of tech-heavy but growth-oriented stocks. The lack of a long track record (this fund started only in March 2011) is not a hindrance in case of a passive fund.

Between the ICICI and the Templeton fund, you should ideally choose one for the other 50 per cent of your US exposure. Templeton has the advantage that it invests in a mother fund, and the fund house has a sound track record for stock-picking in the US. At the same time, ICICI comes with strong research support from Morningstar. Both funds don’t have an adequate track record (the Templeton feeder fund was also launched only in January this year).

According to Vishal Dhawan, a Mumbai-based financial planner and founder of Plan Ahead Wealth Advisors, “Go ahead and buy both funds. What is more important at present is that Indian investors should build their exposure to international equities in their portfolio as they have very little of it at present. It is difficult at present to choose between the ICICI and the Templeton fund because of a lack of track record. So watch their performances for a while, then cut your exposure to the fund that underperforms and move into the one that outperforms.”

Scheme info at a glance
  • Open-ended equity scheme
  • Will invest in blue-chip companies listed on the stock exchanges of USA -- NYSE and NASDAQ
  • Benchmark: S&P 500
  • Partnership with MorningStar Equity Research Services (MERS)
  • Minimum application amount: Rs 10,000
  • NFO period: June 18-July 2, 2012
 
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