3 Things To Consider Before Investing Into International Funds

With the bellwether Nifty having soared nearly 20 per cent in the past twelve months, many investors are starting to consider investing into International Mutual Funds to achieve geographical diversification within their portfolios at this time. If you're one of them, here are three things you need to consider before you commit your money.

Risks
The risks associated with domestic equity markets are relatively easy to understand. However, the exact risks (and associated returns) associated with a foreign market are relatively opaque, unless you take it upon yourself to do some serious research. Often, what appears to be a shining investment opportunity from a distance can really be a ticking time bomb. For instance, most China focused funds have given investors a 25% plus return in the past year - however, with a debt to GDP ratio as high as 277%, the market may have risks that novice investors will find difficult to understand. To top it off, investing into foreign markets carry currency risks too - if the currency of your foreign fund depreciates, if could lead to a dual negative impact on returns. While the media forcefully keeps us abreast of domestic events that could impact equity returns, regular information flow related to the market that your international fund invests into could be less forthcoming.

Tax Efficiency
Many investors harbour the false belief that international funds, being equity oriented, will attract equity taxation and therefore provide them with tax efficient returns. However, this isn't quite the case. Current taxation norms stipulate a minimum allocation of 65% to domestic listed companies in order for equity taxation to apply to a mutual fund scheme. While there's a sub-category of international funds (for instance: Templeton India Equity Income Fund and Birla Sun Life International Equity Fund - Plan B) that are tax efficient as they deploy up to 35% of their moneys to international equities, the others are actually treated as "non-equity" from the taxation standpoint. What this implies is that if you're looking for tax-efficient returns from your international fund, you'll have to wait three years in most cases. That's not an ideal scenario for those looking to switch from one market to the other in line with shifting trends.

Fund Selection
Primarily, three kinds of international mutual funds exist today. The first combine Indian and international equities in a tax efficient manner, as described above. The second use a 'feeder fund' mechanism to collect moneys locally and 'feed' them into an international fund in a specific region (such as China, US or Japan). The third kind invests in specific themes in international markets - such as Gold Mining, Agriculture and Energy. The first carries the lowest risk as the currency risk and information asymmetry associated with them are the least. The second category of funds carry risks that are unique to the particular market that the fund is committed to. The third are the highest risk, and may not make sense for most investors. You need to keep two things in mind while selecting an international fund to invest into - one, do not chase past returns or invest based on tips. Two, do not avoid a particular fund simply because it's short term returns haven't been up to the mark. A thorough evaluation of the target country's economic prospects is warranted, before you decide to sign up.

End Note
Despite their slightly higher risk and relative opacity, there's a case for geographical diversification through international mutual funds at this stage, while Indian markets await actual earnings growth to come through and provide it with the next fillip. New investors could consider taking the SIP route and opting for the first category of funds, in order to take a more measured allocation to them. Savvier investors could consider the second category that focuses on a particular geography in entirety. As far as international markets go, China may have become too risky for comfort at this stage, whereas the U.S and Japan remain relatively balanced from a risk-reward standpoint.