You have an option to invest in international markets through the mutual fund route. Indian mutual funds offer a host of funds that invest internationally. Called international funds, these funds invest in international equities or bonds and money market instruments. Let us look at the types of international funds and some of the pros and cons of investing in them.
Types of International Funds and where they invest
International funds offered by Indian mutual funds can be classified based on the type of exposure they take. For example, there are country specific funds, that invest in a particular country like US, China or Brazil. Then there are region-specific funds such the ASEAN fund or emerging markets fund which invest in the countries in the respective region. Apart from country specific and region-specific funds, there are theme-based international funds as well. Commodity funds for example, invest in commodity-linked companies such as mining companies and metal trading companies. Then there are also international funds that invest in themes such as world energy, global consumption, agriculture and so on.
Mode of investment
Indian mutual funds invest in international markets either directly or invest in other funds in those markets. The latter is called feeder route and is typically in the form of a fund-of-fund. The good thing about your investing in these funds is that you invest only in your own currency, that is, rupee, whether the fund invests directly in international markets or through the feeder route. Investing in these funds have pros and cons. Let us look at some of them.
Pros of Investing in International funds
Diversification and hedge: One of the key arguments in support of investing in international funds is the diversification they provide to your portfolio. As not all markets behave alike, at the same time, it helps to spread your money across different markets. For example, in 2016, when the Indian Equity markets struggled to return 3%, the US markets returned over 13% and some country specific funds even delivered in excess of 20%. Hence diversification into other markets can help reduce portfolio volatility.
Access to broader markets: International mutual funds provide access to markets that may otherwise be difficult for an investor to gain access to. For example, if you want to take exposure to US blue chip stocks, it may cost you several lakhs of rupees to even own one of them. And not all brokerages in India provide access to international markets. Also, while markets like the US are open there could be other emerging markets that require additional regulatory compliance. More importantly, the kind of companies/opportunities available abroad (say a Google or a Microsoft) may not be available in the Indian markets.
Hence whether it is a matter of hassle-free, convenient investing into other country markets or tapping unique opportunities elsewhere, with the limited money that an investor may have, international funds are a good option.
Limitations and risks
International funds generally carry all the risk that pertains to investing in the markets, but additionally carry two other major risks as well.
Currency Risk: Currency risk arises from fluctuation in the value of other markets’ currency against the Indian rupee. While you will be investing in the rupee, the fund house will have to take exposure to international stocks in different currencies. As a result, fluctuation in the currency equation can cause volatility in your NAV. For example, if your fund invests in US markets and the rupee depreciates against the dollar, you will get more rupees for every dollar invested in that country and to this extent, your NAV will be higher. However, if the rupee appreciated against the dollar then you get fewer rupees for every dollar invested there and your NAV will take a hit to that extent.
Political and economic risks: Adverse political and economic developments in the country of investment would lead to a volatile market in that country. As a result the NAV of the fund may get impacted negatively.
Lack of information on underlying funds: Most of the International mutual funds invest either through a fund of fund structure or through a feeder fund. Hence most of the time there may not be adequate information available for Indian investors on the underlying funds.
Taxes: When it comes to taxation, international funds are treated on par with debt mutual funds. This is because to qualify as an equity fund, for tax purposes, a fund has to hold at least 65% in Indian equities. Since these funds invest in international stocks, they do not qualify as equity fund for tax purposes.
For a holding period of less than three years, the investor is required to pay short term capital gains tax on the profits at his/her tax slab. When the fund is held for more than three years, the investor will get indexation benefit as the profit is treated as long term capital gain. Post indexation, the gain is taxed at 20%.
International funds provide an opportunity to diversify one’s portfolio. However, understanding of the foreign market is one, entering and limiting the exposure to such markets may be necessary to gain benefits while lowering the risks.