Is the rupee depreciation affecting your fund NAV?

This week the Indian rupee touched a two-year low against the US dollar. So far this year, the rupee has declined 7.5% against the US dollar; since July, it has declined 7.5%. Traders expect rupee to decline further. Unless you have an export import business or you are a non-resident Indian or a foreign investor in the Indian financial markets, this news may not catch your attention.

But there is a part of your investments, unrelated to the above which may be affected by the sharp decline in rupee. If you invest in mutual funds (MFs) having exposure to international equities, chances are that a portion of their net asset values (NAVs) are being affected by the currency movement.

The currency effect

While taking advantage of currency movement is unlikely to be the main reason for investing in an equity fund that has exposure to international stocks, the fact is any substantial currency movement will affect the fund’s NAV.

This happens because you buy fund units in Indian rupees, but the international stocks that form part of the fund are bought in the local currency of the country. When you invest, your rupee is first converted to dollars and subsequently to the requisite currency of the country where the stock or fund units are bought. The opposite happens if you redeem.

If this was a straightforward rupee to dollar or vice-versa conversion, then a weakening rupee will have a positive impact on the NAV. However, life becomes difficult if the transaction involves a third currency; the rupee must depreciate against the US dollar more than the third currency has depreciated for it to add a positive edge to the overall returns. If on the other hand the third currency has appreciated and the rupee has declined against the dollar then the advantage because of this currency movement on the overall fund returns will be even greater.

So you need to consider the equation with the third currency to assess the overall impact on returns along with the sudden sharp decline in rupee per dollar on funds’ NAVs. Says Jaya Prakash K., head (products), Franklin Templeton Investments India, “Regional/global equity funds investing directly in overseas securities will be affected by the movement of individual currencies, trading and stock prices, rather than rupee’s behaviour against the US dollar alone.”

Other factors

There are other factors involved, the most important being the underlying asset class.

Typically, you would invest in a fund that has exposure to international equities for diversification. Says Laxmi Iyer, head (fixed income and products), Kotak Mahindra Asset Management Co. Ltd, “Investors choose these funds as an option for geographical diversification. Management of these funds is more to take advantage of that aspect and currency is more incidental.”

Many equity funds which have exposure to overseas markets, invest in commodity stocks, emerging market equities and stocks related to gold. The underlying stocks have their own dynamics which dictate return. For example, while gold mining stocks have done well, emerging market equities, particularly Asian equities, have done poorly and this is reflected in the overall returns. Gold funds on the other hand have performed well so the currency effect may not be that much.

In most cases, the effect on returns on account of currency movement is secondary, with the asset class performance being the primary factor. Moreover, there are too many variables to consider and it’s unlikely to be a linear correlation with fund returns.

Source: http://www.livemint.com/2011/09/21231044/Is-the-rupee-depreciation-affe.html?h=B