When investing, diversification is considered to be a prime aspect to avoid certain risks. It is possible through many ways like asset class vis-Ã -vis, equity, debt, commodities and realty. Further diversification is possible through investing in different sectors and different companies. Lastly, even geographical diversification is possible by investing in international funds.
The international funds are present in India for more than a decade and there are 41 schemes as of date with an asset under management (AUM) to the tune of Rs. 13,300 crore. Though the AUM numbers do not indicate any significant interest towards the international funds, there is some amount of interest visible as new investors try to understand the field. Further, the way larger corporations like Google, Microsoft, Apple and Tesla are making it to the news of scaling new high levels – the interest has increased significantly.
However, with global investors focusing on India as a larger growth opportunity, does it make sense taking exposure to the international mutual funds? Let us try to understand the structure and importance of international funds.
What are international funds?
International funds are equity funds that invest overseas. Such funds invest in stocks of companies listed outside the Indian markets. For instance, an US large-cap equity fund invests in large-cap companies like Apple, Microsoft, Procter & Gamble and Amazon.
These funds can be broadly classified as thematic, region-specific, country-specific and global. Thematic funds have a specific focus like commodities, real estate or energy. Region-specific funds, in-turn, have regional focus (say Asia-pacific or Europe). Similarly, there could be a country focus like that of the US, China or Japan while global funds invest without any geographical barriers. Many of these funds operate as a feeder fund whereby they invest in a globally managed international fund. While most are actively managed funds, some funds also mimic global indices.
International mutual funds follow a master-feeder structure. A master-feeder structure is a three-tier structure where investors place their money in the feeder fund which then invests in the master fund. The master fund then invests the money in the destination markets. A feeder fund is based on-shore i.e. in India, whereas, the master fund is based off-shore (in a foreign geography like Luxembourg etc). A master fund can have multiple feeder funds. As regards the cap on investment, one can invest up to USD 250,000 under Liberalised Remittance Scheme (LRS).
Different Types of International Mutual Funds
Each fund adopts a different approach to global investing, such as investing in companies, regions, countries, themes, and funds that invest in both Indian and foreign companies. To make it simple, these could be bucketed as funds that are thematic, region, and country-specific, and those that have a wider global exposure. Following are different types.
The thematic international funds invest in specific and narrow themes like mining, realty, etc.
The region and country specific international mutual funds diversify geographically into countries and regions. The objective of most of these fund schemes is to primarily explore the opportunities in regions and countries.
The global markets funds are broadly diversified funds across the globe.
Why do investors go for international funds?
The first and foremost reason is, investors are benefitted by investing in the growth of renowned multinationals which are not listed in India. There have been great returns generated by few of the large corporations like Tesla, Apple and Google have been much better than what Indian listed companies have provided. It is a fact that when a larger opportunity moves upwards, there is broader wealth creation. Such opportunities are not available in the Indian markets. For instance, some technology-based sectors such as search engines, payment infrastructure, cloud computing and digital over-the-top (OTT) platforms have clocked good growth globally and such opportunities are not widely available in the Indian listed place. International funds give access to such opportunities on international platforms.
The second factor is, investors can take advantage of the difference in currencies which can be a source of gains on its own or can even be considered as a de-risking strategy. International funds provide geographical and portfolio diversification with a currency hedge. From about Rs. 45 to a dollar in 2000, we are staring at Rs. 75 to a dollar currently, which could be used by investors to their benefit by taking foreign currency exposure by investing in rupees.
Lastly, one can diversify equity portfolios beyond the Indian stock market. Remember not all economies move in tandem. Every economy goes through its periods of ups and downs which in turn impact its companies and its stock prices. By investing in companies of different economies, one is definitely managing the risk.
Analysing some aspects
We have listed a few advantages of investing in international mutual funds. There are two major risks with investing in international funds. The first is the currency exchange difference. Though it comes as an advantage if our currency depreciates, there is a vice-versa possibility.
Secondly, any economic and political changes can impact one’s investment, which is a significant and unpredictable risk. Further, there are taxation complications as well.
Taxation impact
International funds are given a similar tax treatment as that of debt funds. So, if one holds on to these funds for a period of three years, the investor gets indexation benefits while the net capital gains are taxed at 20 per cent. So, on the taxation front, the international looks like a costlier proposition against regular equity funds. Equity funds are taxed at 10 per cent only if capital gains are more than Rs. 1 lakh in a financial year.
Conclusion: With benefits like diversification, currency hedging and access to newer business ideas, one could use the allocation to international mutual funds as a tactical allocation. But it is important to have close watch when invested in them. Of course, international funds are not always in sync with returns from investments in Indian funds. It is important to understand all the advantages and disadvantages while investing in international funds. It is advisable that one could start with small investments and factor its role in the portfolio before committing to more investments in an international mutual fund.