Overseas investments, a foreign idea to most of us, could work for some of us
By: Tavaga Research
The world has shrunk due to technology, and finance is no different. Tremors felt in one market reverberate in other markets in real-time. However, economies don’t always reflect each other due to inherent drivers, and this could mean better returns in some parts of the world than others going through a slowdown. Does it make sense for us to look outside India to invest at this time, then?
Investing in international financial instruments is a distant proposition for many of us. There are so many homegrown ways of investing, some of which if explored to the hilt, may reveal themselves as surprising fits for our money goals.
The Indian stock markets, the lifeblood of wealth-creation in an economy, are operated through only 39.7 million demat accounts. That means just about 3 percent of our population own a demat account and participate in our financial markets.
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The MF AUM to GDP ratio (signifying penetration of such products) of India is a paltry 11 percent. Brazil, another emerging economy like India, has a ratio of 59 percent. While the global average is 62 percent, the developed economies have higher ratios, like the US with 101 percent, France 76 percent, and the UK 57 percent. Financial literacy at the same time is low for many of us.
The twin aspects of low penetration and literacy in the Indian financial sector could discourage us further from looking outwards. But in a slowdown, such an option may gain greater relevance.
International funds may offer us a way to diversify with familiar instruments. Many of the retail investment options we know of are present in other countries, which can be accessed by us. Moreover, in mature economies, these products are far more nuanced than what we get here. For example, ETFs.
What are the different types of foreign investments?
We may, of course, look at direct investments in foreign stocks or stocks of companies based in other countries. There are ways of turning to pooled investment funds as well, much like ETFs and MFs that are popular devices in India.
International ETFs: These investment funds, a form of pooled investment, invest in foreign indices such as the S&P 500 or the Nasdaq in the US, or the Nikkei in Japan. These ETFs would essentially be a basket of stocks that constitute the indices they follow.
As with passive investing instruments, these ETFs let us invest in foreign equity stocks without high risk as the stocks are often a part of benchmark indices.
Some of the ETFs available to us are MOSt Share NASDAQ 100 issued by Motilal Oswal AMC, and the Reliance ETF Hang Seng BeES issued by Reliance Nippon Asset Management.
Some of the advantages which a foreign ETF has over domestic ETFs:-
ETFs listed on exchanges of developed economies have an edge over ETFs listed in India because of liquidity. Liquidity refers to the ease with which investors can transact among themselves without incurring heavy impact cost. ETFs in exchanges of developed countries are more liquid than what we have here in India.
Mature markets have ETFs that are more nuanced while we have only straightforward ETFs (but still more advantageous than active investment products like MFs).
International mutual funds: Investors with relatively small portfolios, such as retail investors, may choose MFs registered in India but investing in foreign stocks.
ICICI Prudential US Bluechip Equity Fund, Aditya Birla Sun Life International Equity Plan A, Franklin Asian Equity Fund offers investors opportunities to invest in equities all around the world. MFs such as DSP US Flexible Equity Fund, Edelweiss Greater China Off-Shore Fund invests in other international mutual funds which have foreign equities as their holdings, i.e. they take the fund of fund(FoF) route to investment.
Other kinds of investment funds opening up the international markets for us are:-
Feeder funds: These act as go-between an international mutual fund (not registered in India) and routes our investment to the fund house in the foreign market.
Fund of funds (FoF): FoFs registered in India may have international MFs in their portfolio as these are funds that invest in different MFs with pooled investments (instead of directly buying stocks). FoFs usually juggle different mandates as they may access multiple MFs, hence, diversification for the investor is a key benefit.
Direct investment: Of course, there are ways to directly invest in markets offshore, as well.
Indian retail investors looking to invest in company stocks of foreign countries may do so through foreign brokers.
Foreign brokers like Interactive Brokers LLC have a presence in India, allowing us to buy international stocks. The process is as simple as opening an account with an Indian brokerage.
Homegrown brokers such as HDFC Securities, ICICI Securities, and Axis Securities have tied up with foreign brokers to provide a facility to invest directly in stocks and bonds.
HDFC Securities has tied up with US-based broker, Stockal, a global investment platform. ICICI Securities and Axis Securities have tied up with a Danish investment bank, Saxobank.
How to invest in international funds?
One of the ways to invest is to buy the funds which are offered by an AMC operating in India with a mandate to invest in foreign stocks. The other way is the LRS, under which we have to open an account with a foreign broker and complete the due process as required by different countries.
What are the benefits of foreign investments?
It is always advisable to take the SIP route, rather than side with a lump sum in investment funds, and foreign funds are no different.
Diversification is an important aspect of investing, the ie. the idea of not putting all our (investment) eggs in one basket.
Foreign investment acts as a diversification tool. Diversification, relevant to retail investors as well, should be done with investments across asset classes, styles, and geographies. It stabilizes our portfolio, and a single threat does not jeopardize all our instruments to earn returns.
Investing in international funds helps with the last — not concentrating risk to one economy’s ups and downs. Country-specific risk, as a business owner might tell us, is a veritable problem, and while retail investors may not actively seek out such safeguards, knowing a little more about it could come to our aid as the Indian markets mature with time.
Even when our own economy hits the doldrums, a livelier economy in another country of investment would prop up returns on our overall portfolio.
Besides, diversification, we may also turn to foreign shores for stock investments for these reasons:-
Investing in favorite brands — There are consumers and then there are brand advocates among us. The likes of Apple have loyalists across the globe and like Apple, many international brands have made efforts to become more inclusive in pricing. For aficionados of a brand, investing in the growth of the very name they swear by could make for a strong pitch. Investing in brands we interact within our daily lives makes sense to many of us. Other popular listed international brands include e-commerce company, Amazon, streaming service, Netflix, and social media giant, Facebook.
New opportunities — Some economies have investment products which are more transparent than the usual instruments we find in India. There could be thematic investment products that align with our values. If we remove our India-only filter and look to other markets, we may find more of these. For example, an ETF tracks an index with stocks of companies with the lowest carbon footprint or the best corporate social responsibility.
Currency benefits — When investing in foreign securities, a depreciating rupee (against the country’s currency) will buoy the returns we earn on them. For example, the over-5-percent depreciation of the rupee against the US dollar in the last year has ensured amplified one-year returns on US funds.
Foreign investment limit
We, as investors, are limited by RBI regulation to invest overseas. The Liberalised Remittance Scheme (LRS) was introduced by RBI in February 2004, to facilitate Indian resident citizens to remit abroad for permitted transactions under current or capital account.
All transactions which do not change the asset and liabilities of an individual outside India are considered as current-account transactions, whereas those transactions which change the assets and liabilities of an individual are considered as capital account transactions. Under the remittance scheme, an individual can remit up to $250,000 (Rs 1.78 crore) in a financial year.
The LRS was set up under the legal framework of Fema (Foreign Exchange Management Act), which oversees all foreign transactions undertaken by a citizen.
The LRS, of course, is RBI’s way of protecting us from risks to an extent. As with investments of all kinds, international investment funds and stocks bring with them their own set of risks.
Risks of investing overseas
Currency risk — If we are directly investing in foreign assets, currency risk has to be factored in. Just as with a depreciating rupee, we stand to gain in international funds, with the trend reversed, we would make a loss.
Say, we have invested $10,000 in a growth-style ETF offered by a US-based AMC a year ago. The investment has now risen to $12,000. We might be elated at the gain but on the forex front, it could be a different story. What if the dollar to rupee rate was 73 when we had bought the ETF units but it came down to 71 at present? Our loss in forex would amount to 2.73 percent. For foreign investments, just as with other overseas assets, we must keep the risk of currency fluctuation in mind.
Geopolitical risk — The crisis of war, natural calamity, political instability, or a trade war would be difficult to forecast or control but could have an adverse impact on our investment.
Interest rate risk — Unfavourable monetary policy changes in the foreign country where we are invested would affect our returns too. Any change in the key rate of a country can change that market’s dynamics.
We need to take care in choosing our securities, because of these inherent risks. Investment funds in the US have done well compared to those in some Asian and Latin American markets.
How are international funds taxed?
The tax treatment of international funds is similar to that of debt funds in India. If the holding period is less than 36 months, our returns are included in our individual gross total income and taxed according to our tax slab. If the holding period is more than 36 months, the gain arising from the sale of the fund units (or returns) are taxed at 20 percent, after including the indexation benefits.
Investing globally in the current times
The slowdown in the economy may have driven us to ask if we should look beyond Indian shores for investment opportunities.
Investing in international markets such as the US, China, and Japan would enable us to participate in their growth.
The US economy, in contrast to ours, is robust, with its unemployment index reaching a 50-year low. The Indian markets are twice as volatile as US markets, which could mean US investment funds’ favorable reward-to-risk ratio for those of us considering them.
The performance of the Dow Jones Industrial Average, one of US’ premier equity index, and the Dollex (Sensex converted in dollar terms), in the last 27 years, shows the former beating the latter. Since 1990, Dow Jones (index) has given 8.65 percent (compounded annual growth rate) while the Dollex has given 8.6 percent.
Is foreign investment good?
For all the talk about diversification, we must remember Indian equities have outperformed US stocks on many occasions, mostly because the markets are far from maturity and saturation.
There are over 5,000 listed companies in the Indian stock market. And, it is no secret that we, Indians, are underinvested in our own markets.
International investments cannot substitute Indian equities or funds in our portfolios but rather, be a portion in them.
Whether foreign investments are good for us or not depends on our investment style. International investments afford us certain features that we don’t get from Indian instruments, as enumerated in the benefits listed earlier.
If we set them aside for a moment, the money goal of an expected expense in a foreign currency could also lead us to international investments.
It could aid a much-anticipated foreign luxury tour or tuition in a foreign university, after a few years of being invested, provided forex works in our favor.
But the outperformance of the US markets should not lead us to think all global markets are performing well.
So, before putting down our hard-earned money anywhere, we have to scope out which countries are expected to perform well to make for a meaningful addition to our portfolios. The role of an adviser is indispensable in most of our cases for such products, arming us with the relevant information and expectations.