Planning To Invest Into International Funds? Consider This First

With equities witnessing a broad-based correction post the RBI’s recent decision to ease liquidity conditions, a lot of investors were considering diversifying into international funds – only to discover that inflows into a number of them had been stopped to ensure that the industry-wide overseas limits were not breached! If you’re planning to invest into them once the temporary block is lifted, here are three things you should condsider.

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. Take last year – U.S technology stocks were skyrocketing as paradigm shifts due to COVID made investors ultra-bullish, and mutual fund companies were quick to cash in on the opportunity by launching and promoting a host of U.S Tech focused funds. Now, most of these funds have delivered returns of -30% to -35% over the past 6 months alone, with the NASDAQ falling like nine pins!

Additionally, 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. With the INR at an all time low against the USD, keep in mind that investing in USD denominated stocks carries an additional layer of risk in case the USD corrects from here.

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 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 Technology, FAANG stocks, 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

With domestic markets correcting of late and entering reasonable valuation multiples, why look outside India? It makes a lot more sense to concentrate your investments into top performing domestic equity funds instead.