Like investors across the world, investors in India have a strong home bias – that is, most, if not all, of their investments are in India. While the Indian economy has been doing well over the medium term, the fact is that our GDP is just over 3% of the world GDP, and as such there are many opportunities for investments outside of India as well. Further, some global markets have done very well, and it is worthwhile to explore investments opportunities in those geographies for investors.
Investors who have been investing in Indian equities for some time, and are comfortable with such investments, could consider geographical diversification and look to invest in equity of listed companies outside of India. By doing so, they may partake in the returns of well-performing companies abroad while also diversifying the country risk.
There are two routes using which investors can invest abroad. Under the Liberalised Remittance Scheme (LRS), an individual can now invest up to USD 250,000 annually in foreign assets. Alternatively, an individual may invest in an Indian mutual fund that invests either a part or whole of its assets in offshore equity.
There are numerous funds dedicated to investing in offshore assets, with some devoted to themes, such as commodities, EMs, Global smaller cap companies, etc. In addition, there are equity funds that invest the majority of their assets in Indian shares, while also investing a significant part of their portfolio in global listed equity. For tax purposes, such funds are treated as domestic equity funds while offering diversification benefits to the investor.
Geographical diversification allows the investor to spread the country risk while also enabling them to be a shareholder in some of the best-performing and innovative companies in the world. These could be companies that own well-known brands or those discovering new cures in the healthcare space, for instance.
Further, as we know, economies have different cycles of growth. While some are on the upswing, others may be experiencing a downturn. The COVID-19 pandemic has hit all economies, but their pace of recovery has varied as we have seen so far. We have also observed the trend of some people experiencing a gradual increase in foreign liabilities, either by way of funding a child’s education or for travel expenses etc. By investing abroad, a foreign investment can act as a natural hedge for such liabilities.
One common question asked by investors while investing abroad is about the currency risk. Here, it must be pointed out that the Indian Rupee has had a gentle but consistent depreciation against some of the most developed country currencies. For example, the Indian Rupee has declined by 22 percent against the USD in the past five years. To this extent, currencies are usually expected to add to the returns.
Investing abroad through mutual funds is still a nascent activity for Indian investors. A small portion of the mutual funds’ AUM are invested in foreign assets. This is beginning to change, with a growing appetite for foreign assets being seen among distributors and investors. However, it should also be noted that this is a gradual change. Offshore investing is now an attractive idea, given the ease and the low cost through which it can be done via mutual funds. Additionally, it introduces diversification as well as provides access to some of the best-performing companies in the world. Global diversification makes the investors’ portfolio more holistic, and can usually help in reducing the volatility in the portfolio.
Finally, in terms of taxation, equity funds that invest at least 65 percent in Indian equity and part of the balance in offshore assets are treated as domestic equity funds and taxed as such. Funds that are dedicated to be invested in foreign assets are treated like debt funds. If units are sold before three years, the capital gains are treated as short term; added to one’s income; and taxed at the rate applicable to the income slab. If held beyond three years, a 20 percent rate applies to the gains with indexation benefits.
(Rajat Jain is Chief Investment Officer at Principal Asset Management)