Planning to Invest in International Funds Consider This First

0

As equities witnessed a widespread correction after the RBI’s recent decision to ease liquidity conditions, many investors were considering diversifying into international funds – only to find that inflows into a number of them had been stopped to ensure that the whole sector abroad the limits were not exceeded! If you’re considering investing there once the temporary lockdown is lifted, here are three things you should consider.

Risks

The risks associated with domestic stock 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 looks like a brilliant investment opportunity from a distance can actually be a ticking time bomb. Take last year – U.S. tech stocks soared as paradigm shifts due to COVID made investors ultra-bullish, and mutual fund companies were quick to capitalize on the moment by launching and promoting a multitude of American technology-focused funds. Today, most of these funds have generated returns of -30% to -35% in the past 6 months alone, with the NASDAQ plummeting!

Additionally, investing in foreign markets also involves currency risks – if the currency of your foreign fund depreciates, it could have a double negative impact on returns. While the media keeps us informed of national events that may impact equity returns, the regular flow of information related to the market in which your international fund invests may be less available. With the INR at an all-time low against the USD, keep in mind that investing in USD-denominated stocks carries an additional level of risk in case the USD corrects from here.

Tax efficiency

Many investors harbor the false belief that international funds, being equity-focused, will attract taxation of stocks and therefore provide them with tax-advantaged returns. However, this is not quite the case. Current tax standards stipulate a minimum allowance of 65% to domestic listed companies for equity taxation to apply to a mutual fund regime.

While there is a sub-category of international funds that are tax efficient as they spend up to 35% of their money in international equities, the others are actually treated as “non-equities” from a tax perspective. . This implies that if you are looking for tax-efficient returns from your international fund, you will have to wait three years in most cases. This is not an ideal scenario for those looking to move from one market to another based on changing trends.

Fund selection

Mainly, three types of international mutual funds exist today. The former combine Indian and international stocks in a tax-efficient way, as described above. The second uses a “feeder fund” mechanism to raise funds locally and “feed” them into an international fund in a specific region (such as China, the United States or Japan). The third type invests in specific themes in international markets – such as technology, FAANG stocks, gold mining, agriculture and energy. The first involves the lowest risk because the exchange rate risk and the information asymmetry associated with it are the least important. The second category of funds involves risks specific to the particular market in which the fund is engaged. The third are the most risky and may not make sense to most investors. There are two things you should keep in mind when selecting an international fund to invest in – firstly, don’t look to past performance or invest based on advice. Second, don’t shy away from a particular fund just because its short-term returns haven’t been up to snuff. A thorough assessment of the economic prospects of the target country is warranted, before you decide to enroll.

Endnote

With domestic markets correcting late and entering reasonable valuation multiples, why look outside of India? It makes much more sense to concentrate your investments in the best performing domestic equity funds.


Share.

About Author

Comments are closed.