Are Developed Market Funds Offering Worthwhile Opportunities to Indian Investors?

December 13, 2023 Mutual Fund

In the midst of a dynamic transformation in the Indian economy, many investors are looking beyond the domestic market for diversification and growth opportunities. Developed market funds, investing in established economies like the US, Europe, and Japan, have emerged as a compelling option for Indian investors seeking to expand their portfolio horizons.

However, the question remains: do these funds truly offer worthwhile opportunities, or are there hidden risks lurking beneath the surface?

This article delves into the potential benefits and drawbacks of investing in developed market funds for Indian investors, helping you navigate this increasingly popular investment avenue.

Investors willing to diversify by investing in international market can do so directly by investing in stocks or through the international or global mutual fund category. These funds add a layer of geographic diversification to the diverse range of mutual fund types currently available in India.

[Read: Is It Worthwhile Adding International Mutual Funds to an Investment Portfolio?]

Global diversification may help you expand your portfolio and seek additional growth opportunities. These investments could be securities that you would have missed if you had only invested in opportunities in your home country. Foreign Investment may allow you to get back up in times of domestic market downturn.

Furthermore, it allows investors to invest in a variety of markets, sectors, industries, risk courses, and other areas.

What are developed market funds?

International mutual funds that invest in developed markets like the US, Europe and Japan are known as developed market funds. The process of investing in international mutual funds is identical to that of investing in any other equity mutual fund. Investors receive units of the funds in exchange for their money, which is invested in rupees.

The funds are invested in stocks of companies listed on exchanges outside of India by the fund management. Now, there are two ways in which the fund manager invests your money in foreign stocks.

• By directly purchasing stocks and building your portfolio;
• Or by investing in an existing global fund that already has a pre-designed portfolio consisting of foreign company stocks;
• Or passive investing which is index mutual funds that aim to invest in global indices like developed market indices – NASDAQ, MSCI world index and S&P 500, etc.

Consequently, they are administered by Indian mutual fund companies and like all other mutual funds, they are regulated by the Securities Exchange Board of India (SEBI).

International mutual funds offer Indian investors an exciting opportunity to diversify their portfolios and gain exposure to global markets. These funds invest in a variety of assets outside India, such as stocks, bonds, and real estate, allowing you to tap into the growth potential of developed and emerging economies.

Here’s a closer look at the types of International Mutual Funds:

• Global Funds that invest in a basket of stocks and bonds across the world, providing broad diversification across markets and sectors.
• Regional Funds that focus on a specific region, like the US, Europe, or Asia, offer targeted exposure to that region’s economy.
• Thematic Funds that invest in specific themes like technology, healthcare, or infrastructure, regardless of geographical location.
• Also, International Debt Funds invest in fixed-income instruments like bonds issued by governments and companies outside India.

However, due to changes in taxation, a cap on mutual fund investments overseas, and the average returns provided by the global equities markets, international mutual funds have tapered off over the last two years.

The declining demand is especially noticeable because it follows the extraordinary rise in international mutual funds that began in January 2020.

According a mutual fund research tool – ACE MF data, there were 33 overseas funds available in the Indian market with total assets under management (AUM) of Rs 7,598 crore at the end of January 2020. This jumped to 66 funds at the end of September 2023 with an AUM of Rs 47,850 crore, with an sixfold increase.

This shows that mutual funds investing in overseas funds have hit a wall in the last 20 months, beginning January 2022. While foreign inflows into Indian international mutual funds have been impressive in 2023, Indian investor participation has also shown encouraging growth.

Indian investor inflows into international mutual funds have reached Rs 32,000 crore (approximately USD 4 billion) year-to-date as of October 2023. This represents a significant increase from the Rs 25,000 crore (approximately USD 3.1 billion) invested in 2022.

There has been an increased awareness and understanding of global investment opportunities among Indian investors. The search for diversification beyond the Indian market to mitigate risk and access potential growth in developed and emerging economies. Additionally, there is a motivation to hedge against rupee depreciation through diversification of currency exposure.

These developed market funds can offer interesting opportunities to Indian investors for several reasons:

1. Diversification – Investing in developed markets like the US, Europe, and Japan allows you to diversify your portfolio, reduces your exposure to domestic risks, and helps you capture potential growth opportunities in other parts of the world.

2. Growth Potential – Developed markets tend to be more mature and stable than emerging markets like India. This can lead to lower volatility and steadier long-term growth. Additionally, certain sectors within developed markets, such as technology and healthcare, are experiencing significant growth, which could benefit Indian investors.

3. Currency Exchange – Investing in developed markets can provide exposure to different currencies, which can be an additional source of return if the Indian rupee depreciates.

4. Moderate Risk – While developed markets are not immune to economic downturns, they are generally considered to be moderately risky than emerging markets. This can be appealing to investors who are seeking a more conservative approach to their investments.

5. Hedge Against Inflation – Developed market currencies tend to be more stable than emerging market currencies, which can help to protect your purchasing power against inflation.

However, there are also some risks associated with investing in international mutual funds.

The value of your investments may fluctuate due to changes in exchange rates, causing currency risks. Developed markets are not immune to geopolitical risks, such as wars or terrorist attacks, which could impact the performance of your investments. For instance, the Russia-Ukraine and Isarel-Gaza wars had an impact on the global market performance.

Developed economies are susceptible to economic slowdowns of the respective country, which could lead to lower returns on your investments. Also, developed market funds may have higher expense ratios than Indian mutual funds. Different countries have different regulations for mutual funds, which may add complexity to your investment decisions.

The returns chart portrays, although international mutual funds follow an uptrend on a year-to-date basis till October 2023, their performance has been poor in the long-term. Over a 3 to 5-year period, these funds have generated around 5% to 10% returns, which are lower than some of the domestic debt mutual funds.

International mutual funds started gaining traction with Indian investors a few years back when the US technology-led index, NASDAQ 100, performed exceedingly well. The term FAANG stocks (Facebook, now Meta, Apple, Amazon, Netflix and Google, now Alphabet) gained prominence. However, given the slowdown after 2022, there is less interest in such funds since the returns have been weak.

Moreover, from an Indian mutual fund’s standpoint, the cap of USD 7 billion on overseas investing was hit in January 2022. Indian investors invested USD 3-4 billion in foreign schemes over the course of two years, 2021-2022, hitting the industry-wide mutual fund ceiling of USD 7 billion. As a result, further investments into overseas funds had to necessarily cease.

Given the sharp rise in interest rates in 2022 and 2023, there was uncertainty and an economic slowdown in Europe and the US, and China is also experiencing a downturn. Currently, India is looking at a bright spot while the rest of the world seems to be slowing down.

In established economies like the US and Europe, GDP growth has not been very robust. Hence, the returns for the last 5-10 years have not been that substantial.

What is the tax Implication on International mutual funds?

Up until March 31, 2023, international mutual funds benefited from indexation and were regarded as debt funds for taxation purposes. On the other hand, as of April 1, 2023, the Union Budget 2023 eliminated the indexation benefits for debt mutual funds.

Investors in international mutual funds as well as domestic debt funds have been impacted by the new tax regulations. Any gain or income resulting from the transfer, redemption, or maturity of units after April 1, 2023, shall be regarded as short-term capital gains under Section 50AA of the Income Tax Act and will be taxable at the applicable slab rate to the investor, irrespective of the period of holding.

[Read: 3-Tiered Taxation of Mutual Funds: Here’s All You Need to Know]

While some international funds have a limited exposure to global equities, others have a 100% exposure to overseas stocks. Consequently, your international funds will be taxed as debt funds without the indexation benefit if they have less than a 35% exposure to Indian/domestic equities.

Should one consider investing in international mutual funds?

With India having one of the strongest economies, investors are actually better off being in Asia and emerging markets than in Europe and the US, given the current global macroeconomic headwinds. It’s worth noting that international funds are better suited for experienced or professional investors, ones that have already built a sizable equity portfolio of domestic holdings as well.

If investors are looking to diversify their investments geographically, then one may consider looking at gold and overseas investing as options, provided that their exposure is limited to no more than 5-10% of the overall portfolio. An alternative would be to think about investing in a combination of developed and emerging market funds.

Whether or not developed market funds are right for you depends on your individual investment goals, risk tolerance, and time horizon. It is important to consult with a SEBI-registered financial advisor before making any investment decisions.

This article first appeared on PersonalFN here