For MF investors, the window to the world is widening

Windows to the world are quickly opening up to investors. Just six months ago, the fund cap was doubled to $ 600 million and the ETF’s limit quadrupled to $ 200 million.

The fund houses were quickly adopted. No less than 16 of the 53 international programs on the market today were launched after March 2020.

So, why consider diversification?

Diversification helps investors better manage volatility and navigate different market seasons. To better understand, let’s take a look at the correlation of Indian and foreign stock markets over the past 10 years. An analysis by CRISIL Research (see graph) shows a weak positive correlation which varies by market. A correlation greater than 0.80 is considered strong, while the correlation of the S&P BSE Sensex ranges from 0.05 (relative to the Shanghai Composite) to 0.53 (relative to the Straits Times Index).

The lack of a strong correlation implies that another index is doing well while Indian indices are not, meaning that investors can profit from the rally in the other market for as long as it lasts.

So, how do you gain exposure to foreign stocks?

A resident Indian can invest in foreign stocks either by buying them directly or by taking indirect exposure through mutual funds. The direct route has an investment limit of $ 250,000 per year in foreign stocks under the Reserve Bank of India’s liberalized money transfer program. The indirect route is more convenient as domestic funds gain exposure to managed funds or stocks listed on stock exchanges outside of India. This route allows investors to participate in topics such as energy, mining and commodities, so far unavailable in India.

But two things deserve to be watched closely.

Currency movement: The performance of international funds is impacted by currency fluctuations as well as by the market value (MTM) of the underlying components. It is positively impacted by the depreciation of the national currency. For example, if an investor puts ₹1 lakh in an international fund on March 1, 2018, when the rupee conversion rate was ₹65.16 per US dollar (1,000 units @ 1 unit per US dollar) and ended on May 31, 2021, when the conversion rate was ₹72.62 per US dollar he would have earned ₹7,460 [1,000 units x (72.62-65.16)] due to the conversion factor, assuming there were no MTM gains / losses on the investment. The exact opposite is also likely.

Taxation: Although international funds invest in different asset classes, including stocks, the resulting capital gains are treated the same as those of debt funds and taxed accordingly. Capital gains with a holding period of less than three years are assimilated to short-term capital gains, added to the investor’s income and taxed according to the applicable tax bracket. On the other hand, capital gains over a holding period of more than three years are classified as long-term capital gains and taxed at 20% after indexation.

And never lose sight of the basics.

The euphoria around international funds is not without reason. These funds certainly help spread risk and allow participation across geographies, currencies and varying market conditions.

However, we must not forget the basics. The commandments are therefore: invest according to your risk profile, your investment objectives and your time horizon; ignore greed and fear; and perform the essential due diligence before taking the plunge.

Piyush Gupta is Director of Fund Research, CRISIL.