Mf category analysis china focused indian mutual fund schemes

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Mutual Fund Category Analysis February 05, 2013
Category Analysis: China Focused Indian Mutual Fund schemes
Relative performance of Indian Mutual Fund schemes which focus primarily on Chinese stocks:

Note: Trailing Returns up to 1 year are absolute and over 1 year are CAGR. NAV/index values are as on January 28, 2013.

Key takeaways:
The Indian Mutual Fund schemes which invest predominantly in Chinese markets are likely to deliver notable
returns going forward given the upward momentum in Chinese stocks in the recent periods that are rebounding
from distressed levels.
Reflecting these sentiments, these China focused equity oriented schemes have done comparatively well in the
past and managed to outperform their benchmarks, domestic counterpart indices and domestic diversified equity
category.
The pessimism over China growth story in 2012 was unwarranted even as the valuation of Chinese stocks became
extremely cheap and the economy started to bottom out and turned around. Given that the growth forecasts are
being revised up, combined with very cheap valuations, Indian investor may capitalize this opportunity by
investing in the above mentioned schemes to participate in the China’s rebound growth story.
Given the fact that Chinese equities bear comparatively little correlation to the Indian equities, high risk appetite
investors who wish to add geographical diversification to their portfolios can consider investing in the schemes
with minimum investment horizon of two years or so.

China Focused Indian Mutual Fund Schemes Retail Research

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Mutual Fund Category Analysis contd…
China - a growth perspective in the near term:
China, the world's largest emerging market, is showing signs that the economic slowdown is gradually improving
and China is ready to become the primary driver of global economic growth.
China is one of BRIC (Brazil, Russia, India and China) countries, which are labeled as the high economic growth
regions all over the world.
The Chinese economy has been witnessing decelerated growth in the recent years on the back of various issues.
The market has underperformed MSCI Emerging Markets by about 10% over the last three years (ending December
31, 2012).
The Shanghai Stock Exchange composite index has closed last month at a four-year low. Chinese stocks are selling
at a significant discount to both other Asian emerging market countries and to their own historical averages.
However, the pessimism over growth has been unwarranted given the fact that the valuation of Chinese stocks has
become extremely cheap and the slowdown in the economy has started to bottom out and turned around.
Latest economic data shows more positives than negatives and the recent destocking phase appears to be largely
over. The economic growth will continue to benefit from the investment momentum in the infrastructure sector,
ending de-stocking in the manufacturing sector, and accommodative liquidity conditions.
The new leadership appears poised to implement potentially transformational reforms beginning in 2013, which
should have important effects on strengthening critical segments of the economy including consumption, banking,
the stock market, currency, and infrastructure, through an increased emphasis on urbanization.
Improved demand, renewed price uptrend, continued double-digit growth in industrial enterprises profits and
earnings upgrades which turned positive in the last month (first time since June 2011) are the positive tickers to
the investors sentiment.
Overall speaking, China equities are likely to continue their recovery in the short term as expectations of a
cyclical improvement for the China economy coupled with potential economic reform measures and a pickup in
corporate earnings will continue to drive the normalization of market valuations.


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GDP growth comparison:

Global stock market PE ratios:


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Domestic Mutual Funds Focusing mainly on Global Equities:
Indian Mutual Funds that invest primarily in foreign economies are called as Global Funds.
There are 33 schemes in the Indian Mutual Fund Industry coming under Global funds category and investing
predominantly in overseas markets either directly or through fund of fund routes. They enable Indian investors to
expose into foreign equities.
Why invest in Global Mutual Funds? The category is considered as good alternate asset class as they provide
geographical diversification, offer an opportunity to take part in the world’s booming economies and growing
stock markets.
By investing in global mutual funds, investment portfolios become further diversified because these funds get
exposure to industries that may not be well represented in Indian market. There may also be times when the
domestic share market is weak but some overseas markets are performing well. Of course, there will be lesser
risks if the fund's reach is wider. However, given the global uncertainty, investors can take a call on schemes that
provide better geographical as well as market diversifications based on their risk profiles.
Country Specific Global Mutual Funds: The Global Funds are further classified as Broad based and Country or
region specific funds. In this note, we cover country based Global Funds that invest primarily in Chinese equity
markets.
Advantage & Disadvantages of investing in Country specific Global mutual funds:
Advantages: The primary advantage of investing in country specific global funds is that the stock markets of such
countries are often uncorrelated with the domestic market. Investing in diverse and uncorrelated assets gives the
best long-term results because different assets classes will do well at different times. The added risk that one
accepts by investing in these countries can lead to larger gains.
Disadvantages: The drawback to investing abroad is that some of the factors that affect the success of investment
are difficult to understand, or predict. Political unrest can lead to losing an investment in a particular country.
Losses can also be created by the relationship between the multiple countries, or by large shifts in the currencies
in play.


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Chinese focused Indian mutual Funds: There are three mutual fund schemes in India which predominantly
investing in Chinese equity markets such as JPMorgan JF Greater China Equity Off Shore, Mirae Asset China
Advantage and GS Hang Seng BeES. JPMorgan JF Greater China Equity Off Shore and Mirae Asset China Advantage
are Fund of Funds (FoF) while GS Hang Seng BeES is an Exchange Traded Fund (ETF).
The underlying fund for JPMorgan JF Greater China Equity Off Shore is JPMorgan Funds - JF Greater China Fund
which invests primarily in companies from the People’s Republic of China, Hong Kong and Taiwan (Greater China).
This tracks MSCI Golden Dragon Index (Total Return Net) as benchmark.
The underlying fund for Mirae Asset China Advantage Fund is Mirae Asset China Sector Leader Equity Fund which
invests in equities of sector leading companies domiciled in, or exercising a large portion, of their economic
activity in China and Hong Kong.
GS Hang Seng BeES is an Exchange Traded Fund which tracks Hang Seng Index as benchmark. Hang Seng Index is a
constituent of 50 largest companies of the Hong Kong stock market and is the main indicator of the overall market
performance in Hong Kong. It represents about 60% of capitalisation of the Hong Kong Stock Exchange.
Basic details:


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Performance:
.red

The mutual fund schemes that focus mainly on Chinese equities have managed to outperform/track closely their
respective benchmarks as well as domestic indices during various time frames all thanks to the rebounded Chinese
equity markets coupled with depreciation of INR against USD.
Like India, China has been also the victim of global headwinds over periods. However, the Chinese equity market
gained positively in the recent periods on the back of some early signs of stabilization in the economy in the fourth
quarter 2012 coupled with the sharp rally of the China onshore equity market.
JPMorgan JF Greater China Equity Off Shore, Mirae Asset China Advantage and GS Hang Seng BeES clocked 29%,
19% and 29% of CAGR returns for the last one year period respectively. For the same time the domestic barometer
Sensex delivered 18% while Average of Indian MF Equity Diversified Category and MSCI All China (INR) posted 19%
and 17% of returns respectively. The three year performance also commendable for the funds in comparison to the
benchmarks.
Relative Performance of the Chinese focused schemes Vs. Benchmarks:


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Correlation among indices and currencies:

Chinese focused Indian MF schemes got benefitted on the back of INR depreciation against USD:


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Other Facts:
A country specific global mutual fund is one in which the manager selects securities from a specific country in an
attempt to mirror or outperform the prevailing stock index in that country. Further, investment in emerging
markets are subject to a higher volatility than more developed markets due to greater political, tax, economic,
social, and foreign exchange, risks, etc.
The size and trading volume of securities markets in emerging markets may be substantially smaller than
developed markets (though not in the case of Chinese market). This may subject the funds to higher liquidity and
volatility risks. Custody and registration of assets in emerging markets may be less reliable than in developed
markets, which may subject the funds to higher settlement risk. These funds may be subject to higher regulatory
risks due to low level of regulation, enforcement of regulations and monitoring of investors’ activities in emerging
markets.
Currency risk: As the investors broaden their investment universe by investing through global funds, they must
also bear the risk associated with fluctuations in exchange rates. (the rupee is first converted into dollar and then
into the local currency for investing abroad and vice-versa).
Fluctuations in these currency values, whether Rupee or USD or the currencies of the countries where the mutual
funds invest, can either enhance or reduce the returns. To put in simple terms, if the rupee appreciates vis-à-vis
the dollar, the returns from the scheme (that invests in US$ denominated assets) will be adversely affected and
vice-versa.
Higher Cost: In case of FoF, expense fees and management costs are higher than normal MFs, as the cost structure
will include the fees of the underlying mutual funds as well as the FoF. Expense ratio for these funds ranging from
0.42% to 2.50%. This excludes the expenses ratios of funds in which these funds invest.
Tax Implication: Global funds lose out on capital gain and DDT benefits as far as tax implication for Indian
investors are concerned as they are treated like debt oriented funds and not equity oriented funds. Hence, They
are liable to pay income distribution tax (DDT) of 12.5% and 30% ( + sur-charges & Cess) on the distribution of
income to individual and Corporates, respectively. Short-term capital gains are taxable as per the investor’s tax
bracket while long term capital gains are taxed 10% without indexation or 20% with indexation.


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Appendix A:
Benefits of investing in Global funds:

1. Diversification: Investors can diversify their portfolio through geographical diversification in addition to
domestic asset classes like equities, debt, commodities etc.
2. Stability: Global markets often perform in contrast as different countries go through different economic
cycles. By having investments across countries and currencies, investors can ensure steady and stable
returns on their investment.
3. Hedging: Investors who have future dollar expenses (for example, parents planning to send their children to
US for higher education, importers having dollar commitments, etc.) can hedge against any future
depreciation in the rupee vis-à-vis the US dollar by investing in such schemes.
Risks of investing in Global funds:
1. Currency risk: The fluctuations in the currency will still have a good or bad effect on the portfolio despite
the fact that the international economies are doing quite well. Its hard to say that deprecation in Rupee
value versus USD always benefits the global funds, which depends mainly on the countries where the funds
exposed to.
2. Fund manager’s expertise: The performance of global funds depend on the expertise of fund managers in
handling international funds as this involves not only economic forecast of different regions,commodities
etc but also rupee-dollar and other currency equations.
3. Higher Cost: In case of FoF, expense fees and management costs are higher than normal MFs, as the cost
structure will include the fees of the underlying mutual funds as well as the FoF. Expense ratio for these
funds ranging from 0.42% to 2.50%. This excludes the expenses ratios of funds in which these funds invest.
4. Country-specific risks include political and economic instability in the country your investments are
exposed to.


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Appendix B:
Understanding the Chinese Stock Market:
Stocks Introduction:
A – Shares: China A-shares, which comprise the 55% of the total China equity opportunity set, are securities listed on the Shanghai or
Shenzhen Stock Exchanges and traded in Renminbi. Presently, China A-shares are only accessible by foreign investors via the QFII
scheme, mutual funds operated by managers with a QFII quota or through the participation in the A-share ETF products listed mainly in
Hong Kong.
B - shares are China securities incorporated in China and listed on the Shanghai Stock Exchange (in US dollars) or Shenzhen Stock
Exchange (in HK dollars).
H-shares are China securities incorporated in the People’s Republic of China (PRC), listed on the Hong Kong Stock Exchange and traded
in Hong Kong dollars.
Red Chips refer to China securities that are not incorporated in the PRC, but that are listed on the Hong Kong Stock Exchange and
(directly or indirectly) controlled by organizations or enterprises that are owned by the state, provinces, or municipalities of the PRC.

P Chips are China securities owned by PRC individuals, incorporated outside PRC and listed on the Hong Kong Stock Exchange. These
companies typically derive a majority of their revenues from the PRC and/or have the majority of their assets located in the PRC.
As of July 31, 2012, these B, H, Red Chip & P Chip share classes collectively represented approximately 42% of the total China investment
opportunities as proxied by their index market capitalization weights.
Major Exchanges in China:
Shanghai Stock Exchange (SSE) was founded on Nov. 26th, 1990 and in operation on Dec.19th the same year. It is a membership
institution directly governed by the China Securities Regulatory Commission (CSRC). A large number of companies from key industries,
infrastructure and high-tech sectors have not only raised capital, but also improved their operation mechanism through listing on
Shanghai stock market.

Shenzhen Stock Exchange (SZSE)，established on 1st December 1990, is a self-regulated legal entity under the supervision of China
Securities Regulatory Commission (CSRC). SZSE is committed to its mission to develop China’s multi-tier capital market system. It gives
full support to development in small and medium businesses and implementation of the national strategy of independent innovation. The
SME Board was launched in May 2004. The ChiNext Market was inaugurated in October 2009.


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Major stock indices in China:
Shanghai Composite Index is an index of all stocks (A shares and B shares) that are traded at the Shanghai Stock Exchange. The base day
for SSE Composite Index is December 19, 1990. The B share stocks are generally denominated in US dollars for calculation purposes. For
calculation of other indices, B share stock prices are converted to RMB at the applicable exchange rate (the middle price of US dollar on
the last trading day of each week) at China Foreign Exchange Trading Center and then published by the exchange.

The SZSE Component Index is an index of 40 stocks that are traded at the Shenzhen Stock Exchange. The base day for SZSE Component
Index is July, 20, 1994 and the base value is 1000. Only companies which meet the criteria set by the SZSE are possibly selected as
constituent stock of the Index, including a long history as a listed enterprise, a market cap large enough, a positive earning scenario,
being actively traded and representative in its industry or sector.

CSI 300: As a joint venture between the Shanghai Stock Exchanges and the Shenzhen Stock Exchange, the China Securities Index
Company Limited (CSI) is a professional business entity specializing in the creation and management of indices and index-related
services. CSI 300 aims to reflect the price fluctuation and performance of China A share market.

Hang Seng Index was started on November 24, 1969, and is currently compiled and maintained by Hang Seng Indexes Company Limited,
which is a wholly owned subsidiary of Hang Seng Bank, one of the largest banks registered and listed in Hong Kong in terms of market
capitalisation. Hang Seng Index is a constituent of 50 largest companies of the Hong Kong stock market and is the main indicator of the
overall market performance in Hong Kong. It represents about 60% of capitalisation of the Hong Kong Stock Exchange.

Analyst: Dhuraivel Gunasekaran. (Database sources: AMC Sites, NAVIndia and Ace MF)

HDFC Securities Limited, I Think Techno Campus, Bulding –B, ”Alpha”, Office Floor 8, Near Kanjurmarg Station,
Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Phone (022) 30753400 Fax: (022) 30753435
Disclaimer: Mutual Fund investments are subject to risk. Past performance is no guarantee for future performance. This document has been
prepared by HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. This document is not to be reported or
copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The
information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not be relied
upon as such. We may have from time to time positions or options on, and buy and sell securities referred to herein. We may from time to time
solicit from, or perform investment banking, or other services for, any company mentioned in this document. This report is intended for non
Institutional Clients.


Mf category analysis china focused indian mutual fund schemes

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