Should you invest in international funds?
An International equity fund is one such way to capitalize on the prospects of global leaders. Should you own them?
You socialize on Facebook, shop on Amazon, watch movies on Netflix and ‘Google’ for all sorts of information. As a consumer, we trust various brands and as a logical extension, sometimes even want to own its shares. At least the Peter Lynch fans.
However, many such global leaders are not listed in India. By investing in overseas equity, you get an opportunity to make it part of your portfolio.
An International equity fund is one such way to capitalize on the prospects of global leaders. Should you own them?
What are international funds?
International equity funds are equity funds that invest in stocks of companies listed outside of India. For instance, a US large-cap equity fund invests in large-cap companies like Apple, Microsoft, Procter & Gamble, and Amazon.
International funds can be broadly classified as thematic, region-specific, country-specific, and global. Thematic funds have a specific focus like commodities, real estate, or energy. Region-specific funds, in turn, have a regional focus (say Asia-pacific or Europe). Similarly, there could be a country focus like that of the US, China, or Japan while global funds invest without any geographical barriers.
Many of these funds operate as a feeder fund whereby they invest in a globally managed international fund. While most are actively managed funds, some funds also mimic global indices.
Why do people invest in these funds?
There are broadly three reasons:
1. Benefit by investing in the growth of renowned multinationals which are not listed in India.
Some technology-based sectors such as search engines, payment infrastructure, cloud computing, and digital OTT platforms have clocked good growth globally and are uniquely positioned to capitalize on disruptions caused by the pandemic. Since companies in these sectors are not adequately listed in India, investors can benefit by investing in international funds.
2. Take advantage of the difference in currencies which can be a source of gains on its own or de-risking strategy.
Aided by rupee depreciation against the dollar, some US equity funds have posted robust returns. International funds benefit whenever the rupee depreciates against a currency since your portfolio returns (earned a say in dollars) are enhanced in rupee terms.
3. Diversify your equity portfolio beyond the Indian stock market.
Every economy goes through its periods of ups and downs which in turn impact its companies and its stock prices. By investing in companies of different economies, you are definitely managing your risk – since all economies (and therefore their stock market) don’t necessarily move in tandem.
While all seem a good trigger to buy international funds, there are a couple of caveats:
1. Don’t chase high returns
Investors should not get swayed by the high returns of international equity funds of the past as it is likely to ‘normalize’ over the long run. So, focus more on asset allocation and the need for portfolio diversification.
2. Tax googly
These funds are given the same tax treatment as that of a debt fund. So, if you hold on to these funds for a period of three years, you get indexation benefits while the net capital gains are taxed at 20 percent. It makes these funds a costlier proposition as against regular equity funds that are taxed at 10 % only if capital gains are more than Rs 1 lakh in a financial year.
3. Don’t bet on currency
A lot also depends on the region or country chosen for currency gains. While the rupee has depreciated against the dollar benefitting the US fund, it might not be the case for a global fund that invests in multiple currencies. Moreover, currency movements are volatile and rupee value fluctuates based on global fund inflows. So, currency appreciation cannot be an investment trigger.
4. Economic and political risks
Every economy is exposed to demand and political risks. These risks are higher for smaller economies and those having a higher share of their GDP in the form of exports. Any global fall in demand can impact its economic growth and local stock prices grievously.
A possible Investment approach
1. Stick to large economies
The US economy is large and developed with many of its companies listed on its exchanges and well-regulated. It is safer to invest in such large economies. Regional and global funds can also be chosen as long as they don’t take riskier bets.
2. Currency-denominated hedge
Investing in international equity is a good way to meet your foreign currency-denominated goals such as children’s higher education in the US. It will provide a natural hedge to the risks in currency fluctuation.
3. Limit exposure
Interestingly, some regular equity funds also capitalize on international stocks by investing in them. If you seek full-fledged exposure, you can go for international funds. However, restrict exposure based on your investment needs and goals.
Takeaway
International equity funds offer portfolio diversification but come with an element of risk. Invest only after understanding their full workings.