- Date : 02/07/2021
- Read: 12 mins
Growing awareness of investment options in other territories and the advantages of portfolio diversification, especially during economic turmoil at home, have made foreign funds popular.
As the US cruised to economic recovery in the New Year with job openings rising to a two-year high in February, a second wave of the pandemic buffeted India, leaving domestic investors a worried lot.
On April 23, a day after India’s daily COVID-19 cases breached the 3 lakh mark, credit rating agency India Ratings and Research scaled down the country’s growth forecast for FY22 by a few percentage points.
The downgrade was small, but it reflected the simmering worry. In a nod to this general uneasiness, benchmark indices too corrected during the month from their record highs in February.
Experts think this is a blip and expect a fast recovery post the second wave. But as an investor, don’t you wish for a chance to dabble in the US markets and make some gains there while waiting for the uncertainties at home to blow over?
If you do, the answer is right before you – through what is known as international mutual funds (IMFs).
What are international mutual funds?
IMFs are mutual funds that invest only in foreign companies and foreign markets. Also referred to as overseas or ‘foreign’ funds, they have started becoming popular over the past two decades in India.
IMFs are often erroneously confused with ‘global funds’, which are a separate category of funds. While IMFs invest only in foreign markets, global funds invest in foreign markets as well as the investor’s country of residence.
The idea of investing abroad started gaining traction across the globe when investors in various countries started becoming increasingly aware of investment options in other territories, and saw the advantages of portfolio diversification, especially during times of economic turmoil at home.
Consequently, fund houses began offering innovative schemes across market types, sectors, and risk classes. IMFs were one such class of product.
In India, the Reserve Bank of India (RBI) gave the green signal to IMFs in 2007, allowing each fund a corpus of $500 million. Currently, Indian investors have the option to invest in the US, Europe, China, Brazil, and Asian and Emerging Markets.
Related: Diversify your equity portfolio by investing in stocks overseas
Categories of international funds
Apart from the International Mutual Funds and global funds, such foreign market funds come in three other categories, these being:
- Regional funds: These focus on a particular geographic region. This allows investors to focus on markets of their choice, as they can buy a few regional funds rather than invest in a global fund that has a presence across nations that the investor may not be interested in.
- Country funds: These funds invest in only one foreign country, which makes it easier for the investor to study the market in detail and decide accordingly.
- Global sector funds: These funds focus on a specific sector of the economy in other territories. For instance, the pharma sector of various countries should be of hot interest to many overseas investors, and these funds are the route to tapping that sector/industry.
How international mutual funds work
International mutual funds follow a three-tier structure whereby investors place their money in a feeder fund based in their country, which then invests in a master fund based in another country, which in turn invests the money in identified mutual funds in the international market.
There can be multiple feeder funds located in different countries investing in one master fund. For Indian investors, the feeder fund will be in India, with the master fund probably in the US. This master fund will also receive investments from investors in other countries (say Japan and China). The master fund will then invest everyone’s investments in the specified market.
Apart from the geographical territories listed earlier, where Indian investors can invest through international funds, these funds also offer schemes related to specific market segments such as agriculture, pharma, etc.
This apart, there are schemes that follow a passive investment strategy and invest directly in market indices.
Related: Consider these factors before you redeem your mutual funds
Features of international mutual funds
Let us look at the various features of IMFs that you should be aware of:
Investing in markets abroad exposes you to two types of risk. First, you are looking at other currencies and exchange rates fluctuating almost on a daily basis. If you have invested in a US-centric IMF; you will gain in rupee terms if the rupee falls against the dollar, but lose if the rupee rises.
Second, each country you invest in has its own individual political, social, and economic issues that will have an impact on the performance of the IMF. These developments can pose risks at two levels.
The first is at the market level, where all stocks across industries are affected, because of anyone or several developments. For instance, let us assume you have exposure in China, where the market is in turmoil over a string of cases of trading irregularities involving party members and the state elite. In such a scenario, your investments are at risk.
There is also a risk at the sectoral level, where investment in a particular sector like airlines can be at risk because of external developments such as COVID-19, or internal developments such as unfavourable government policies.
However, since these funds invest in various markets, they will be capitalising on the strengths of many economies simultaneously and fetch you higher returns. Thus, the diversification will not only mitigate the risks faced in one market but will also boost the quality of your portfolio.
There is also the tax angle to international funds. These schemes are treated like debt mutual funds. So, if these investments are sold within three years, the returns would be added to your income and taxed as per your applicable income tax slab. If sold after three years, the returns would be taxed at 20% with indexation benefit.
Related: Types of mutual funds and how to start investing in them
Advantages of international mutual funds
IMFs gained popularity over the past few years, with investors seriously considering them as alternative investment options given the volatility in the local markets across economies. However, like any other investment, investing abroad has its highs and its lows. Let us look at the benefits:
All economies have cycles of ups and downs. So when you add these mutual funds to your portfolio, you increase its geographic diversification and thereby create an opportunity to earn from the positive market cycle of another country’s economy. If you had stayed confined to Indian stocks at home, your returns would be impacted by any adverse movement at home, with no cushion available.
A portfolio comprises investments that carry risks of varying degrees – high, medium, and low. More importantly, the level of risk in the home country may not be the same with that in another country at that point of time. This means if the market is depressed in the home country, it does not necessarily have to be so in another country. So, spreading one’s portfolio can compensate for losses back home.
Not all Indian stocks are cheap, and the domestic markets may have already hit a high. By carefully selecting the right fund, you can invest abroad and balance the costs back home to create a cost-effective portfolio.
International mutual funds allow you to gain exposure to foreign markets through a qualified fund manager.
Top Five International Mutual Funds for Indian Investors
Assuming an investment of Rs 6 lakh via a SIP of Rs 10,000 for five years, the top five IMFs by returns as of May 31, 2021 are:
|Fund name||Current value||Returns|
|Edelweiss Greater China Offshore Fund||Rs 12.37 lakh||29.11%|
|PGIM India Global Equity Opportunities Fund||Rs 11.72 lakh||26.82%|
|DSP World Mining Fund||Rs 11.36 lakh||26.82%|
|Franklin India Feeder Franklin US Opportunities Fund||Rs 11.01 lakh||24.59%|
|Nippon India US Opportunities Fund||Rs 10.75 lakh||23.18%|
Source: ET Money
Who should invest in international funds
IMFs are not for passive investors. To successfully invest in them, the markets in question need to be studied carefully and continuously. International funds are suitable for investors who have long-term goals and are prepared to bear the impact of currency movements and economic upheavals abroad. They must also be aware of ongoing global affairs.
How to Invest in International Mutual Funds
You can directly invest in an IMF an Indian mutual fund scheme that invests in stocks of foreign companies. For this, you have to complete your KYC formalities by filling in the relevant forms as required by the AMC concerned. You can also invest in a fund of funds schemes that invest in foreign mutual funds or whose portfolio mimics a stock market index such as the Nasdaq 100 or S&P 500.
Charges associated with investment and redemption
Before you take the plunge and start investing in IMFs, it is advisable to take note of all the charges like bank charges, as well as the taxes.
- GST on Currency Conversion: GST is levied on the taxable value of the transfer, which is 1% on transfers up to a maximum of Rs 1 lakh; 0.5% plus Rs 1,000 on transfers ranging from Rs 1 lakh to Rs 10 lakh, and 0.1% plus Rs 5,500 on transfers above Rs 10 lakh, capped at Rs 60,000.
- Brokerage Fees: The fees charged by the various brokerages are usually per trade or on the basis of trade volume.
- TDS/TCS on Earnings: All your earnings will be in dollars, and treated as remittances under the RBI's Liberalised Remittance Scheme (LRS), which levies a 5% TCS (tax collected at source) on remitted amounts above Rs 7 lakh. (This means if you receive Rs 9 lakh as earnings from abroad, TCS will be collected on only Rs 2 lakh). Also, you can claim a refund if your tax liability is less than the TCS amount.
- Capital Gains: IMFs are classified as debt for taxation purposes. This means if you redeem any gains before three years, it will be taxed as per your income slab. If you redeem after this period, the tax will be at 20% with indexation.
If the investment was a lump sum made five years before the planned redemption, the gains would qualify for indexation. A Systematic Withdrawal Plan (SWP) will lower, however, your tax burden is spread over a period of time since only the gains of an individual SWP will be taxed.
- Tax on Dividends: Dividend income is taxed both in the US and India. In the US, it is a flat rate of 25%, deducted from your dividend amounts. In India, the dividend amount received is added to your taxable income and taxed as per your income tax slab. However, as the two countries have a Double Taxation Avoidance Agreement (DTAA), you can offset the tax amount paid in the US against your tax liability in India.
Things to remember when investing in IMFs
Before investing in foreign markets, Investors need to be sure of their investment goals, both short-term and long-term, and then check the track records of the various mutual funds to identify one that suits their requirements. They must follow the same rules that apply when investing in a domestic mutual fund:
- Read the offer document carefully and ask for clarifications (if any);
- Understand the investment objective of the fund and the risks it intends to take;
- Analyse if these aspects are in sync with your investment strategy;
Research and assess the feasibility of investing in a region or country for any fund category, be it region-specific, country-specific or commodity-specific fund.
Related: How interest rates impact mutual funds
A majority of Indian investors balk at the prospect of testing global markets. However, global investing is not as complicated as it seems; it can help you achieve a well-diversified portfolio. It not only allows investors entry into larger or fast-growing economies but also throws up specific stocks or sectoral opportunities that are absent in India. Expanding one’s portfolio to global investments also ensures better risk-adjusted returns.
Lastly, given that investors in international funds need to continually study the market, such exposure helps to broaden their experience and expertise. How to choose an equity mutual fund, read more about this.
Disclaimer: This article is intended for general information purposes only and should not be construed as investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.