International diversification is in the spotlight

By Ravi Samalad |  15-09-20 | 

Mouth-watering returns delivered by a few international fund of funds tracking markets/themes like U.S., China and gold mining funds has put the spotlight back on the category which was perhaps most ignored by investors and advisers alike for long.

Take, for instance, PGIM India Global Equities Opportunities Fund which has delivered a staggering 60% return in 2019-20. Another fund by Motilal Oswal AMC which tracks Nasdaq 100 has delivered 59% return. Edelweiss Greater China Equity Fund has delivered 55% during the same period. DSP World Gold Fund has posted 47% return. (Returns as on Sep 2019-Aug 2020.)

It's not just the stellar returns which is driving investor interest towards international investing. Market crashes similar to the one observed in March 2020 in India has reinforced the need for an asset allocation approach in a portfolio; gold, equities, fixed income, international equities, alternative assets.

The need for diversifying away from Indian equities is growing slowly and steadily. Indian asset managers collectively managed a paltry Rs 1,761 crore as on August 2018 in international FOFs. As on August 2020, the AUM has jumped to Rs 5,154 crore, an increase of 193%.

Brands like Amazon, Facebook, Apple, Alphabet (Google) and Netflix are part of our everyday life but not many us would have thought of participating in the growth of these companies by buying their stocks. Indian investors have two options to own these stocks. The first route is through investing in international fund of funds offered by domestic fund houses. The second way is through directly buying these stocks through brokerage houses or digital platforms that have tie-ups with international brokerage firms. Such investments up to $ 2.50 lakh per annum can routed through Liberalised Remittance Scheme.

In response to the growing investor interest, many platforms/brokerage houses like Cube Wealth, Fintso, Vested, Kuvera, ICICI Direct, HDFC Securities have started offering the facility for Indian investors to invest in U.S. stocks and ETFs.

Another option available for financial advisers in India to help their clients diversify internationally is through iFAST platform. Through this channel, Indian investors remit money to Singapore which is then invested in international funds domiciled in Singapore markets. Unlike investing through FOFs offered by AMCs, investing through remittances comes with its own set of challenges. “Unlike in India, there is no concept of nominee in Singapore. If the account holder passes away, to get the estate back, it needs a lot of documents to be submitted to the asset management firm from the court. A client would not want to travel when he is going through the emotional pain of the loss of a family member. One needs to be sensitive to the regulations prevailing in different countries. You have to look at all options of liquidity and exit,” cautions Kukreja.

Fractional shares

Investing in U.S. stocks can be expensive if one invests directly in stocks. Thus, brokerage houses allow Indian investors to buy fractional stocks. For instance, Berkshire Hathway Class A share is worth 3,29,725 USD (as on September 14, 2020), which makes it the most expensive stock, in terms of price per share. This could make the stock out of reach for many retail investors. Fractional shares allow investors to buy a dollar value of a stock irrespective of its price. If one intends to invest $ 1,000, he/she would get 0.0031 units of Berkshire Hathway. Owning fractional shares is not permitted in India.

U.S markets are overvalued

Mumbai-based RIA Melvin Joseph has been recommending international fund of funds offered by AMCs to his HNI clients. Currently, he is avoiding U.S. funds due to the stretched valuations. “I feel Indian equities can do better in comparison to US equities in the long run because we are a developing market. Retail investors who have just started their investing journey should start with Indian equities and then diversify in international equities,” said Melvin.

Investors who are lured by the recent spectacular returns delivered by U.S. funds should not jump into the market blindly. “We think US equity markets, particularly sectors such as technology, are quite overvalued and investor growth expectations over the next 10 years, based on current share prices, from these companies are significantly above historical levels. Currently, our 10-year return estimates from U.S. equities are probably lower than most other major global equity markets. We’re underweight US equities across most of our global multi-asset portfolios,” says Dhaval Kapadia, Director – Portfolio Specialist, Morningstar Investment Advisers India.

Fund of funds or direct equity?

Melvin prefers to provide international diversification through fund of fund route and cautions investors not to directly invest in international stocks without doing proper research. “I’m recommending US international fund of funds to some of my HNI clients who are well diversified in Indian stocks. I usually don’t advise investors who have just started their investment journey to diversify internationally,” says Melvin.

Play on rupee depreciation

The returns which investors would make depends on rupee depreciation as well. The rupee has steadily depreciated against the dollar over the years. For instance, in 2008, the rupee was trading at 48 against the dollar which is today at 73 levels. “Diversification across international geographies also provides a hedge against the currency. The sharp depreciation of the INR vis-à-vis USD or other major currencies in periods of significant market volatility or other economic events, such as the fall in INR vs the USD witnessed in March & April this year, would benefit investments in international equities as the INR value of such investments would rise, assuming that global markets don’t fall as much as Indian markets,” says Dhaval.

What do you get?

Most international fund of funds that invest solely in U.S. markets invest in Nasdaq and S&P index. Nasdaq index is heavily tilted towards tech stocks which account for 57% of the index, followed by consumer services which weighs 22%.

Sector diversification in Nasdaq 100 and S&P 500 indexes

Source: Nasdaq.com

Why diversify?

Delhi-based RIA Amit Kukreja started recommending international funds three months back. He believes that Indian markets have shot up significantly. After the debt fund downgrade events and COVID-19 event, there is too much rush towards buying large caps through mutual funds. He recommends parents who wish to send their children to study abroad should specifically invest in international funds to get a hedge against the fall of the rupee.

According to Dhaval, investing in international equity markets provide an opportunity to participate in growth drivers across various countries/markets. These opportunities can be quite different from those available in India such as large technology companies in the US or automobile/ engineering companies in Germany & Japan.

Dhaval says that predicting which global asset class or market would outperform year-on-year is extremely difficult. Thus, investors should opt for a fund that offers global diversification by investing in multiple markets.

“US constitutes 66% of the MSCI Global Index and US companies have the widest global footprint of earning available. So, you actually get a decent global exposure through US stocks. Further, US markets are liquid and have good corporate governance,” recommends Gaurav Rastogi, CEO, Kuvera.

Passive or active international funds?

Kukreja advises investors to go for a mix of passive and active funds benchmarked to Nasdaq 100 and S&P 500 indexes. “The tilt should be towards passive international funds as alpha generation is a challenge in developed markets. Another advantage is that passive funds based in the U.S. have lower expense ratios as compared to investing through an Indian FOF. The investment horizon should be at least five to seven years.”

Gaurav seconds the view. Rastogi advises investors to opt for low-cost index funds and if they are investing in direct equity, they should look at the company’s cash flows and other quality metrics rather than just price returns.

Taxation

International Funds

Debt funds taxation is applicable if one invests through international FOFs. Short term capital gains are taxed as per the income slab, while long term gains (above 3 years) are taxed at 20% post indexation of costs.

Direct Equity

By buying stocks directly through brokerage accounts, investors pay 20% with indexation benefit as long term capital gains in India if the holding period is more than two years. Capital gains are not taxed in U.S. Short-term capital gains are taxed according to one’s income tax slab. Dividends are taxed in the US at a flat rate of 25%. U.S. and India have a Double Taxation Avoidance Agreement (DTAA), which allows taxpayers to offset income tax already paid in the US. The 25% tax you already paid in the US is made available as Foreign Tax Credit and can be used to offset your income tax payable in India.

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