The East Asian financial crisis of 1997 was disastrous, leaving many poorer in those countries. When the currencies of these countries depreciated in value, so did their assets, leaving many who had their entire investments within their countries on the brink of bankruptcy. Their investments were in a single region and currency. This holds true of most Indian investors as well. What if a similar financial crisis occurs here? In such a situation, only diversification across geographies would protect your portfolio.
In February 2004, the Reserve Bank of India notified the liberalised remittance scheme, allowing resident Indians to invest up to $25,000 per year outside India. This limit has over the years been enhanced to $200,000 per person per year, offering Indian investors adequate scope to invest abroad and benefit from diversification. Mutual funds, the most convenient and cost-effective way to achieve diversification, offer a window to invest abroad through myriad schemes and options. Currently in India 26 funds are available that offer global exposure. They offer investors exposure to varied themes, sectors and geographies.
Why go global?
The reason you should consider global investments is that by spreading your money among several markets, you achieve what stock market theorists have been propounding for years—diversification and hedging risk by spreading it across a mix of assets and markets. Individual economies are subject to economic cycles. By investing in several economies at a time, your portfolio can earn smoother returns.
Besides reducing risk through diversification, global investing can also boost your portfolio returns. With no country managing to be at the top of the charts each year, the case for spreading your investments across countries definitely gets stronger.
Three, international investing offers you a chance to take part in the world’s booming economies and growing stock markets. For instance, Japanese stock markets have been producing poor returns for almost two decades. For a Japanese investor, venturing abroad and investing in one of the world’s better-performing markets is a highly attractive option.
Types of international funds
On offer are three types of funds: those that allow direct investing into global markets; funds that use the feeder route to invest in an existing global fund; and lastly, fund of funds that invest in several funds to achieve international exposure.
Moreover, variety in international funds also comes from the fact that some of them invest in a particular region (say, China or South America). There are others that are commodity plays. They could be investing in gold mining companies or in agri-based companies, and so on. You even have one passive fund here. So, this is obviously a category for the sophisticated investor who knows exactly what kind of exposure he wants.
Many of these funds come with adequate track records that will give you a sense of how they have performed in the past. Select a fund that you are comfortable with.
However, like any other type of investment, investing abroad has its own set of risks as well. There is the risk of volatility in currency exchange rates. If the foreign currency in which your fund is invested falls in value vis-a-vis the rupee, then your investment returns will suffer despite the gains your fund may have made in the market. There is also the issue of taxation (See: Tax conundrum) that could prove to be a potential minefield. The key is to evaluate the pros and cons to see if this investment avenue fits your needs.
A word of caution
Investing in international funds is for mature investors looking to diversify away risks. It is not for those blindly chasing high returns. Once you have some idea of the risks and benefits of global investing, make an informed choice about whether you should enter this investment arena. You could make a cautious start by investing in a sector or theme that you understand and can track. Only then increase your exposure to global markets through global mutual funds.
When investing in international funds you should know the tax treatment that these funds are subject to. Indian tax laws define an equity fund as one with at least 65 per cent of its corpus invested in Indian stocks. If held for less than a year, there is only 10 per cent tax on the profits from equity funds. If the holding period exceeds a year, there is no tax at all.
Since hybrid global funds invest 65-70 per cent of their corpus in domestic companies and the balance in overseas markets, investors in these funds are eligible for the tax exemption on long-term gains from these funds.
The capital gains from other funds that invest in overseas markets are treated in the same way as long-term capital gains from debt funds. In other words, if the holding period is less than a year, the profit is added to the investor’s income for the year and taxed according to his tax bracket. If the holding period is over a year, there is a 10 per cent flat tax or a 20 per cent tax with indexation (which takes into account inflation during the holding period and reduces tax accordingly). Given this, feeder funds and direct investment funds that fall under this category will have to perform much better if they want to compete with hybrid funds.