Over the past few months, mutual fund schemes investing in overseas equity have gained investors' interest. During the last year's crash, these funds fared far better than the schemes investing in domestic equities. Since then, this category has gained popularity. As on March 26, 2021, the category's average one-year trailing returns stood at over 50 per cent.
The total assets managed by the category have increased by more than three times in less than a year, climbing to Rs10,716 crore by the end of February 2021 from Rs3,282 crore in April 2020. Also, the category has witnessed a significant spike in the inflows.
Allocation to overseas funds
Although the recent rally and the stellar performance of international funds have caught investors' fancy, it's always advisable to allocate a small portion, around 20-30 per cent of the equity portfolio, to international equities in order to diversify geographically and reduce risks. Investors with a similar exposure might have witnessed a limited fall in their portfolios as against someone having 100 per cent exposure to domestic equity funds during the market crash led by the pandemic.
Interestingly, apart from having funds that invest only in overseas stocks, these days, fund houses have come up with equity funds that invest in both domestic and international equities. These funds typically invest at least 65 per cent in domestic equities and allocate a small portion, not exceeding 35 per cent, to international equities. As they continue to invest 65 per cent in the stocks of domestic companies, they are treated as an equity fund for taxation purposes and at the same time, add international exposure to the investor's portfolio. Earlier, only Parag Parikh Flexi Cap Fund used to follow this strategy but over the past few months, more fund houses seem to have started adopting it. Such funds can be useful for a small investor who wants to go easy and avoid adding an extra fund to the portfolio.
Nevertheless, if someone has a significant corpus to allocate and is ready to track an extra fund on an ongoing basis, he/she can choose from several funds investing completely overseas. Since these funds do not invest a minimum of 65 per cent in domestic companies, they are taxed as non-equity funds.
The way to choose overseas funds
Many overseas funds are either region-specific or follow a particular theme. For example, a fund may invest in companies domiciled in China, Europe or Brazil, or it may have the mandate to invest only in agriculture-related businesses. However, it's always better to avoid funds with such a narrow universe, as they put restrictions on the fund manager. One should instead look for international funds that have a larger universe. If one avoids region-specific and thematic funds, then one is typically left with US-based and global funds in the category. But a closer look reveals that most of the global funds also invest significantly in companies that are domiciled in the US market. That is because the US lists some of the most fundamentally strong businesses having their customer base across the globe. For example, Amazon, Microsoft, Alphabet, etc.
Another reason for Indian investors to invest in US-based funds is the benefit of foreign exchange. The Indian rupee has historically depreciated against the US dollar and would continue to do so until there is a significant reduction in the difference between the interest-rate regimes of the two countries. In such a scenario, Indian investors gain from a depreciating rupee over the long term, thereby adding some extra return to their portfolio.
However, lately, there is concern about whether the US market would continue to perform well, as it has already experienced a sustained bull run. Many investors are apprehensive of it not performing well in the near future. But one should take a more strategic view and look at the long-term picture. In the 55th Annual General Meeting (AGM) of Berkshire Hathaway held in 2020, Warren Buffett warned investors to "Never bet against America." Despite a wide range of economic possibilities owing to the pandemic, he remains convinced that 'nothing' can stop America.