International funds are investment vehicles that allow investors to purchase a portfolio of securities in companies located outside their home country. These funds provide exposure to a range of foreign markets and can invest in a variety of securities, including stocks, bonds, and real estate, thus providing diversification opportunities for investors. Investing in international funds makes it possible for investors to benefit from the growth potential of foreign markets, access a wider range of investment opportunities and reduce the risk associated with investing in a single country.
The benchmark for an international fund depends on its investment target. A fund focused on investing in China, for instance, might use the Shanghai Composite Index as its benchmark. On the other hand, if a fund primarily invests in the US market, the S&P 500 may be a suitable benchmark.
Investing globally through mutual funds can simplify the process and reduce risk and cost. International funds, which are "fund of funds" that invest in existing global funds, can be an efficient investment vehicle. Mutual funds offer a variety of international funds with themes such as commodities, agribusiness, or specific countries/regions like Brazil, US, Europe, China, Latin America, and ASEAN countries.
Why invest in international funds?
Investors may consider investing overseas for the following reasons:
To take advantage of attractive overall returns (combining international equity and exchange rate movements)
To diversify their investments and reduce risk through asset allocation
To benefit from specific opportunities and have a small exposure in their core portfolio for diversification purposes, or as part of their satellite portfolio. The core portfolio is designed to align with the long-term investment goals and objectives of the investor, while the satellite portfolio is intended to take advantage of anticipated short-term market movements.
While the Indian markets offer growth opportunities, investors cannot ignore the potential investment opportunities that offshore markets have consistently presented. It is therefore crucial for investors to have a flexible and open-minded approach to international investing.
When investing globally, it is important to carefully select the country or region to invest in, with the US markets being a crucial part of any international investment portfolio. While investing in international funds one must bear in mind that the direction of Indian stocks and stocks in emerging markets tend to align frequently. Therefore, for stock investors seeking to purchase globally successful and high-quality companies, the US market offers the most diverse selection of options compared to other global markets.
Points to consider when investing in international funds:
Like any investment strategy, investing globally also has its advantages and disadvantages. The main advantage is achieving true diversification, but it is important to be aware of potential drawbacks. One such factor is geopolitical issues that can affect fund performance. Additionally, an appreciation of the rupee can negatively impact international fund returns. However, this has not been a major challenge in recent years due to the long-term depreciation of the rupee against the US dollar.
Diversification:
Diversification of your equity portfolio is crucial for managing risk. By investing in a diversified equity fund, you can spread your investments across multiple stocks and industries, rather than focusing on just a few. A multi-cap equity fund is a popular choice as a core portfolio option because it balances risk by investing in different market capitalization segments. Furthermore, investing a portion of your portfolio in international markets can provide an additional layer of diversification, allowing you to reduce dependence on the Indian economy or Indian companies. This way, you can protect your portfolio from risks that are specific to the Indian market, such as changes in regulations, government policies, political events, or unexpected events such as demonetization that can impact the Indian economy.
Diversifying your equity portfolio by investing a portion of it in international markets can protect you from domestic and global factors that affect equity returns. This can include foreign investor pullouts, sudden changes in regulations or government policies, events like demonetization, and political risks. Additionally, by having a global exposure, you can mitigate the impact of bearish periods in the Indian market. Historically, Indian indices tend to suffer more than mature markets during global volatility, as this can result in a double hit of falling stock prices and a depreciating rupee. By investing in more mature markets, you can help reduce the risk and smooth out the ups and downs in your equity portfolio.
Investing a portion, approximately 10-15 percent, of one's equity portfolio in international equities can lead to a more diversified geographic spread and lower risk. This way, even during market crashes such as the pandemic, the fall in portfolio value may be limited compared to someone with a 100 percent exposure to domestic equity funds.
Currency Risk:
The Indian rupee has faced difficulties due to global events such as oil-price increases, political unrest, and increasing imports. The value of a currency is determined by the country's current account balance (the difference between exports and imports) and the inflation rate (the purchasing power of the currency). Unfortunately, India consistently runs a current account deficit and has a higher inflation rate compared to developed economies.
Historically, the Indian rupee has lost value against the US dollar and this trend is expected to continue until the difference in interest-rate policies between the two countries is reduced significantly. In such circumstances, Indian investors can benefit from the long-term depreciation of the rupee, which leads to an additional boost in the returns of their international portfolio.
Thus, investing a portion of your portfolio in foreign assets, especially in US dollar-denominated stocks, provides not only the potential to increase your portfolio returns, but also a way to hedge against macroeconomic risks facing India, such as rising oil prices, global interest rate hikes, or risk-averse foreign portfolio investors exiting their investments in Indian equity markets. This helps to turn the challenge of a depreciating rupee into an opportunity to achieve higher returns.
Attractive Dividend Yields:
One compelling reason for long-term investors to explore global markets is the potential for higher dividend yields. Offshore markets may offer more attractive dividends compared to local or even US markets. For example, the markets in Singapore and Spain have been shown to provide higher dividend yields compared to India. Higher dividends are a highly desirable characteristic for investors worldwide.
Mitigating Dollar Risk:
For those who have annual dollar expenditures, such as family members living abroad or children pursuing higher education overseas, or for those who take yearly trips abroad, it is important to consider owning dollar assets in their portfolio. The weakening rupee over time can significantly increase expenses, but holding some dollar assets can help mitigate the impact of rupee depreciation.
How much should you allocate to international funds?
A general guideline is to allocate around 10 to 15 percent of the portfolio to international investments. Although investing in international opportunities can be attractive, the majority of an equity portfolio, particularly for beginner investors, should be invested in domestic funds, given India's growth potential. It is important to prioritize suitability and investment goals and not get too caught up in the allure of global investing.
When selecting international funds, it's better to avoid region-specific or thematic funds that have a narrow investment universe, as they limit the fund manager's investment options. Instead, choose global funds or US-based funds, which typically invest in a wider range of companies, including some of the most strong and stable businesses globally listed in the US market.
It is also important to approach international investing strategically, instead of making investment decisions based on short-term market trends. One must carefully select an international fund, allocate a set portion of the equity portfolio (such as 10%) to it, and maintain that allocation over the long term, with a minimum investment horizon of five years. Regular investment through a systematic investment plan (SIP) would be preferable for the investor.
How to invest in international funds?
This article has already discussed how investing internationally can provide investors with multiple benefits, the most significant being diversification and growth opportunities. A careful examination of the performance of various global equity markets will give investors a better idea of the growth opportunities that exist offshore. Instead of solely focusing on the Indian market, investors should aim for optimal risk-adjusted returns by considering investment opportunities in international markets as well. This can be achieved through international mutual funds or through opening an international trading account to buy and sell specific stocks.
It might be practical to have an overseas investment account only if you are going to invest large amounts (e.g., Rs 10 lakhs or more) and actively manage your stock selections, given the various costs involved such as account opening charges, custodial charges, broking and transaction tax on every buy and sell transaction and currency conversion charges.
Thus it is necessary to keep in mind that the returns from foreign stocks will be influenced not only by the performance of the companies you invest in but also by the exchange rate between the currency you invest in and the Indian Rupee. If you don't have the time for research or if your overseas investment plan is limited, investing in a mutual fund is a simpler and feasible option than trying to manage it yourself.
Tax treatment of international funds:
In India, international funds are taxed like domestic debt funds. Therefore, capital gains from international investments are only eligible for long-term capital gains tax after a holding period of 3 years, unlike domestic equity funds which have a 1-year holding period. However, since indexation benefits are available, a 20 percent tax rate after indexation becomes applicable to gains on international funds. Short-term capital gains in this case are however taxed at the investor's applicable tax rate.
Conclusion
Investing globally is a crucial aspect of portfolio diversification as it allows for exposure to un-correlated international markets. It is important to note that international investing should only be considered after building a solid domestic equity portfolio as investing in foreign markets requires familiarity with equity investments. Diversified investment vehicles like mutual funds or Exchange Traded Funds (ETFs) can be a suitable option for those unfamiliar with international company names. However, it is important to consider the level of risk and potential return as they vary between developed and emerging international markets.
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