Sunday, October 14, 2018

International funds, ETFs and Infrastructure Debt Schemes

International funds invest in markets outside India, by holding certain foreign securities in their portfolio. The eligible securities in Indian international funds include equity shares of companies listed abroad, ADRs and GDRs of Indian companies, debt of companies listed abroad, ETFs of other countries, units of index funds in other countries, units of actively managed mutual funds in other countries. International equity funds may also hold some of their portfolios in Indian equity or debt. They can also hold some portion of the portfolio in money market instruments to manage liquidity.

One way for the fund to manage the investment is to hire the requisite people who will manage the fund. Since their salaries would add to the fixed costs of managing the fund, it can be justified only if a large corpus of funds is available for such investment.

An alternative route would be to tie up with a foreign fund (called the host fund). If an Indian mutual fund sees potential in China, it will tie up with a Chinese fund. In India, it will launch what is called a feeder fund. Investors in India will invest in the feeder fund. The money collected in the feeder fund would be invested in the Chinese host fund. Thus, when the Chinese market does well, the Chinese host fund would do well, and the feeder fund in India will follow suit.

Such feeder funds can be used for any kind of international investment, subject to the scheme objective. The investment could be specific to a country (like the China fund) or diversified across countries. A feeder fund can be aligned to any host fund with any investment objective in any part of the world, subject to legal restrictions of India and the other country.

In such schemes, the local investors invest in rupees for buying the Units. The rupees are converted into foreign currency for investing abroad. They need to be re-converted into rupees when the money are to be paid back to the local investors. Since the future foreign currency rates cannot be predicted today, there is an element of foreign currency risk.

Investor's total return in such schemes will depend on how the international investment performs, as well as how the foreign currency performs. Weakness in the foreign currency can pull down the investors' overall return. Similarly, appreciation in the respective currency will boost the portfolio performance.

Exchange Traded funds (ETF) are open-ended funds, whose units are traded in a stock exchange. Investors buy units directly from the mutual fund only during the NFO of the scheme. All further purchase and sale transactions in the units are conducted on the stock exchange where the units are listed. The mutual fund issues further units and redeems units directly only in large lots defined as creation units.

Transactions in ETF units on the stock exchange happen at market-determined prices. In order to facilitate such transactions in the stock market, the mutual fund appoints intermediaries called authorized dealers as market makers, whose job is to offer a price quote for buying and selling units at all times.

A higher demand for units can push the price of the units higher than the NAV and a lower demand can push down the prices. The authorized dealers can make more units available in the market to meet the higher demand by getting units released by the mutual fund in creation units. They have to submit the underlying assets or cash equivalent with the mutual fund for this. Similarly, they can reduce the available units available in the market by getting units redeemed in creation units.

The major advantage of the market makers is to provide liquidity in the units of the ETFs to the investors.

In a regular open-ended mutual fund, all the purchases of units by investors on a day happen at a single price. Similarly, all the sales of units by investors on a day happen at a single price. The securities market however keeps fluctuating during the day. A key benefit of an ETF is that investors can buy and sell their units in the stock exchange, at real-time prices during the day that closely track the market at that time. This transaction price may be close to the NAV, but not necessarily the same as NAV. Further, the unique structure of ETFs, make them more cost-effective than normal index funds, although the investor would bear a brokerage cost when he transacts with the market maker and need to have a demat account into which the units of the ETF will be credited.

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Infrastructure Debt Schemes
These are closed-ended schemes with a tenor of at least five years that invest in debt securities and securitized debt of infrastructure companies. 90 percent of the fund’s portfolio should be invested in the specified securities. The remaining can be invested in the equity shares of infrastructure companies and in money market instruments. The NAV of the scheme will be disclosed at least once each quarter. The minimum investment allowed in these schemes is for Rs. one crore and the minimum face value of each unit shall be Rs. ten lakh. As a closed-ended scheme the units of the scheme will be listed on a stock exchange. 

An Infrastructure Debt Scheme can be set up by an existing mutual fund or a new fund set up for this purpose. The sponsor and key personnel must have adequate experience in the infrastructure sector to be able to launch the scheme.

Infrastructure Investment Trusts (InvIT) are trusts registered with SEBI that invest in the infrastructure sector. The InvIT will raise funds from the public through an initial offer of units. The offer shall be for not less than Rs. 250 crores and the value of the proposed assets of the InvIT shall not be less than Rs. 500 crores. The minimum subscription size will be Rs. 10 lakh. The units will be listed on a stock exchange.

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