Japanese funds caught between falling rupee and rising yen

Investors in India-focused Japanese offshore funds, which manage about ¥484 billion (around Rs 33,100 crore at current exchange rates), are the worst affected among foreign portfolio investors in the latest currency market carnage, say fund managers who advise these funds.

India-focused offshore funds are not domiciled in India but invest primarily in Indian markets. While most offshore funds are suffering huge losses on account of currency movement, Japanese funds face a double whammy, as they invest money from a gaining currency into a falling one.

According to the BS Research Bureau, the yen has gained close to 10 per cent against the dollar since April. On the other hand, the rupee has fallen 17 per cent this year, most of it coming in the last four months.
 

CATCH-22
Date	Yen/dollar	Rupee/dollar	Rupee/100 yen
31-Dec-10	81.12	44.71	55.00
22-Nov-11	77.04	52.32	67.95
% change	5.03	-17.04	-23.55
Low (Apr 6, 2011)	85.49
High (Oct 28, 2011)	75.82
Diff high - low	11.31
Source: Bloomberg Compiled by BS Research Bureau

“Most long-only offshore funds are facing the new challenge of currency. Everyday, they face a double mark-to-market (MTM), one for the market fall and an other for the currency. They are faring badly,” said a manager with a foreign house which manages a large Japan-domiciled fund.

“Japanese offshore funds are faring worse. In addition to the amplified MTM losses, they are also losing the opportunity cost of staying in the yen, which has appreciated in recent months,” the manager added.

Many offshore funds invest in India through vehicles based in Mauritius to avoid capital gains taxes. Mauritius has a double taxation avoidance agreement with India.

These funds first convert their yen to dollars and then dollars to rupees to buy Indian stocks. The reverse is done for exit. Some Japanese funds also invest directly into India. Even these funds face a rupee depreciation of 23 per cent against the yen, adding to their equity portfolio losses.

Devendra Nevgi, founder and principal partner, Delta Global Partners, said, “It definitely upsets investors who are not hedged.”

Different funds follow different hedging strategies. Some may even decide to leave their portfolios unhedged.

“Losses might differ based on hedging strategies and leverage taken, etc. If some fund has taken a leveraged position, losses could get amplified further,” Nevgi added.

Saurabh Nanavati, chief executive, Religare Asset Management, which advises a couple of Japanese funds, said while offshore funds had generally been hit by adverse currency movements, individual funds with hedging strategies in place would not be hit as much. “One needs to go through the fund documents to understand the hedging strategies,” Nanavati said.

Some large foreign funds have currency overlay strategies, with a separate currency manager taking hedging decisions for all the funds put together. This helps fund managers concentrate on their equity portfolios keeping out the noise on currencies.

According to data with global mutual fund tracker Morningstar, total net assets of offshore India funds in Japan continue to shrink, falling by 24 per cent to close at about ¥484 billion in September. The sharp fall in assets was led by the fall in Indian stocks, coupled with the outflows from these funds.

According to Morningstar, this was the lowest quarterly level of assets for these funds since the first quarter of 2009, when assets had dipped to about ¥429 billion, amid the financial crisis. Assets have fallen by 34 per cent in 2011 (as of September). That was a fall of 65 per cent from their peak of ¥1,400 billion at the end of December 2007.

On a brighter note, while the currency movements are affecting portfolios of existing investors adversely, new investors find it a boon. Nevgi of Delta Global said, “New investors coming in can buy stocks cheaper. On top of the lower stock prices, they are getting a 20 per cent discount on currency. That is a very good opportunity.”