In India, international funds started gaining traction from 2020 onwards when the pandemic crisis ignited a big shift in consumer trends as well as the way organizations work. For many of us, cloud computing, remote working, online shopping, e-payments, machine learning, over the top (OTT) streaming, among other technological trends, have become an integral part of the ‘new normal’.

The companies that enabled the smooth transition into the new normal have witnessed a remarkable rise in their share prices, thereby attracting investors’ attention. And because the shift in trend is expected to continue even in the post-COVID world, these companies have the potential for further growth.

Since most of these corporations are listed on stock exchanges overseas, many fund houses in India are now launching schemes that invest in international equities to give domestic investors an opportunity to benefit from global diversification. Plus, investors are beginning to realize the importance of not limiting the investments to domestic equities.

Consequently, since last year various fund houses such as, Axis MF, Motilal Oswal MF, Invesco India MF, Mirae Asset MF, among others have launched schemes focusing international markets, mainly through Fund of Fund (FoF), Exchange Traded Fund (ETF), or Index Fund route.

In the wake of this, the market regulator SEBI in November 2020 had doubled the overseas investment limit for each mutual fund house to US$ 600 million, the overall industry limit is US$ 7 billion. SEBI has currently raised the foreign investment limit for each mutual fund house to US$ 1 billion, though it did not change the industry limit. Mutual fund houses can invest up to US$ 300 million in overseas ETFs, within the overall mutual fund limit of US$ 1 billion.

Here are the benefits of investing in international market through mutual funds:

1. You, the investor, gain from the expertise of professional fund managers and teams who do the difficult task of selecting securities and portfolio monitoring.

2. International funds offer a hedge against national political instability, policy changes, and other socio-economic issues.

3. Offers access to some unique propositions-stocks/brands/sector, which may be unavailable in the domestic markets.

4. Offers geographical diversification as benchmark indices of different countries vary in performance over different time spans.

5. Provides a hedge against currency fluctuations. This could prove useful particularly when you are planning for your child’s higher education overseas and your home currency is depreciating against the greenback.

But before you decide to allocate your money in international funds be mindful of the following points:

a) Diversify

Investing in funds focused on markets that have lower correlation with the domestic market makes sense. India, a developing economy, has a low correlation with developed economies such as US; therefore, it could provide optimal diversification. On the other hand, investing in other emerging markets similar to India may offer the kind of returns you would earn from investing in the domestic market. In which case, the scope for diversification will be limited.

Invest in funds that hold a diversified stock portfolio instead of investing in funds that focus on a particular sector/theme such as Technology, Healthcare, Consumption, etc. Funds that are sector/theme-oriented could expose your portfolio to concentration risk and prone to high volatility.

You could invest in funds that take exposure to developed markets such as, US, Japan, and Europe, or a global fund that takes exposure in companies across the globe.        

Table: Performance of major world indices over the years

Year	S&P 500	S&P BSE 500	FTSE 100	Nikkei 225	Shanghai Composite
2020	16.26	16.80	-14.34	16.01	13.87
2019	28.88	7.75	12.10	18.20	22.30
2018	-6.24	-3.08	-12.48	-12.08	-24.59
2017	19.42	35.94	7.63	19.10	6.56
2016	9.54	3.78	14.43	0.42	-12.31
2015	-0.73	-0.82	-4.93	9.07	9.41
2014	11.39	36.96	-2.71	7.12	52.87
2013	29.60	3.25	14.43	56.72	-6.75
2012	13.41	31.20	5.84	22.94	3.17
2011	0.00	-27.41	-5.55	-17.34	-21.68

Data as on June 03, 2021

(Source: ACE MF)

b) Know the risks

The performance of an international fund will be impacted by various micro and macro-economic factors of the country the mutual fund house invests in. You must be aware of the country-specific risk factors involved before investing.

Any changes in government regulations and policies relating to companies, industries, investments, and so on may make the investments unattractive. Geopolitical events such as trade wars, border disputes between countries, etc. can impact the performance of the fund.

Moreover, since international funds have exposure to foreign currency assets, fluctuations in exchange rate can impact your returns. For example, if you have invested in a fund focused on US, your returns may drop if Indian Rupee appreciates and US Dollar becomes weak.

Read the Scheme Information Document carefully to understand the scheme’s investment mandate – investment strategy, asset allocation, risks involved, etc.

c) Tax treatment

To be recognised as an equity fund in India and benefit from the favourable tax treatment accorded to it, a scheme has to invest minimum 65% of its assets in domestic equities. Therefore, for the purpose of taxation, international funds are treated as non-equity mutual funds.

Short-term capital gains (gains on investment of up to 3 years) will be taxed as per the income tax slab applicable to the investor, whereas long-term capital gains will be taxed at 20% with indexation benefits.

d) Tactical exposure

Though there is a growing popularity for international funds, invest in them only if you have a well-diversified exposure to domestic equities. Ensure that you have a high risk appetite and have the ability to bear the volatility and risks associated with overseas investments. In addition, your investment horizon should be at least 5 years.

Do not hold international funds as a part of your core portfolio. Instead use it as a tactical satellite allocation to boost portfolio returns while limiting the overall exposure to 10-15% of your equity investment.

e) Select the right scheme

In case of an existing mutual fund scheme, check how it has performed across time periods and market phases. Do not judge a schemes based only on past returns. If you are investing in an international fund that’s tracking an index, it would be beneficial to assess its performance over different market cycles in the past, the index composition, volatility of the index, etc.

To get a sense of how the scheme would perform in the future, try to understand its portfolio characteristics — whether it is well diversified, its sectoral exposure, as well as the individual security weights. Most importantly, an International Fund should stick to the investment mandate. 

Given the way International Funds are structured, their expense ratio is higher than domestic funds. Hence, the returns clocked by the International Fund must justify the expense ratio charged.

Most importantly, invest in schemes backed by a process-driven fund houses that focus on risk management and quality securities.

In conclusion…

Remember that a healthy portfolio is the one that takes calculated exposure across different asset classes, so that if one asset class fails to generate lucrative returns, other asset classes can protect your portfolio from financial loss.

Happy Investing!

This article first appeared on PersonalFN here