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International Mutual Funds: Seven Checkpoints For A Global Investor

Mutual funds companies are like a multi-cuisine restaurant. They offer a vast menu of funds to choose from. This includes diversified equity funds, large-cap equity funds, mid or small-cap equity funds, income funds, short-term or ultra short-term debt funds, arbitrage funds, liquid funds, gold ETFs, gold funds and much more.

Among this immense variety, you will also come across the "international or global" funds. As the name suggests, the investment objective of such schemes is to invest outside India.

International funds have certain peculiarities — notably taxation and currency risk — which make them different from the funds that invest in the Indian markets.

Therefore, (apart from the usual investment parameters), it is important to be aware of these specific differences, before you go global with your investments.

Enumerated below are the SEVEN SALIENT ASPECTS of a typical international or global fund.

1. Taxation
Since tax is an important element of any investment, let's discuss this first.

(As we shall see later why) most international funds are equity-oriented in nature. Hence, for a like-to-like comparison, we will compare taxation on these funds with the domestic "equity-oriented" funds (because different rules apply for equity-oriented and non equity-oriented funds).

Capital Gains on domestic equity-oriented funds are 
a) completely TAX FREE if the holding period exceeds 1 year and
b) taxed @15% for holding period less than a year.

However — and this important — capital gains on international funds are TAXABLE even though they may be 100% equity-based.

The reason being: Domestic mutual funds invest / trade in the Indian Stock Markets, where they pay Securities Transaction Tax. Hence, they have been exempted from long term capital gains tax. Since international-based funds pay no tax in India, the capital gains are taxed.

Accordingly, for international funds the capital gains are taxed
a) @20% with indexation benefit, when the holding period EXCEEDS THREE years, and
b) as per your marginal income tax slab rate if held for LESS THAN THREE years

(Note: For simplicity sake, cess and surcharge, where applicable is not considered.)

Contrary to popular misconception, dividends are taxable income. (Read: Dividends are NOT tax-free). Plus, from the compounding point of view, it is better to let the money grow, instead of taking it out as dividends.Therefore, I am ignoring the taxation on Dividend Option for this discussion.

2. Currency Risk
This is another area, where international and domestic funds differ.

Suppose you have Rs.1 lakh to invest. Assuming the rupee-dollar rate at 65, you can buy units worth around US$ 1,538. After one year, say the units have earned 15% returns. Thus, your investment is valued at around US$ 1,769.

However, (let's forget tax for the moment), your actual returns could be very different when you redeem your units, and receive the value of your investment in rupees.

Case A: The rupee depreciates
Suppose, the rupee-dollar rate goes to 70.

If that be so, on redeeming your units you will receive Rs.1,23,846 (=1769 * 70). Your total profit, therefore, would be Rs.23,846 and the effective returns — after rupee depreciation — will be 23.85%.

In fact, even if your returns outside India were zero, you would have still made a profit of about 7.70%, merely on account of rupee depreciation (i.e. 1538 * 70 = 1,07,692).

Case B : The rupee appreciates
What if rupee becomes stronger after one year and rupee-dollar rate quotes at 60?

Then, your in-hand amount would be only Rs.1,06,154 (=1769 * 60), giving you a net return of merely 6.15%.

In fact, if rupee-dollar rate appreciates to 56.50 or lower, you will be in a loss, despite making 15% gains abroad.

Don't miss reading How Currency Risk Haunts Your Investments And Expenses.

Think carefully before you send your money on a global investment trip.

3. Types of international funds
Actually, international funds is a strange category:

Because, barring a few exceptions, there is no commonality between any two funds. Almost each fund has a different investment objective. Therefore, except for the fact that they do not invest in India, they are completely different in nature and hence not comparable.

Some of the types of international funds are:
- Agri Commodities Fund
- Global Commodities Fund
- Global Real Estate Fund
- International Equity Fund
- Europe Equity Fund
- US Equity Fund
- World Energy Fund
- World Gold Fund
- World Mining Fund
- ASEAN Equity Fund
- Emerging Markets Fund
- China Equity Fund
- Asian Equity Fund
- Brazil Equity Fund
- Japan Equity Fund
- Hang Seng Equity Fund

As you will observe, even within the international funds category, there is a wide variety. Thus, you can choose the idea that you think is the most lucrative, and which adds value to your domestic portfolio.

Besides, some are active funds that invest directly; while others are passive funds viz. ETFs and Fund of Funds. 

4. Hybrid international funds
As mentioned under taxation, long term capital gains tax is zero on domestic equity-oriented funds.

For taxation purposes, a domestic equity-oriented fund is one that invests at least 65% of the corpus in the Indian stock markets.

Taking advantage of this definition, there are certain hybrid funds which invest 65%+ money in India and the balance around 35% in the international markets. Thus, they enable you to enjoy the benefits of global investing, but with the more favourable taxation as applicable to purely domestic funds.

Therefore, from tax efficiency point of view, you can surely consider such domestic-plus-global hybrid funds.

5. No debt-oriented international funds
Debt funds invest in fixed income interest-paying products such as bonds, debentures, commercial paper, Govt. securities etc.

Interest rates in the advanced economies like Europe, US or Japan are at near-zero levels. As compared to these and other large economies in the world, interest rates in India are at much higher levels.

Therefore, it makes no sense to invest outside India, if the objective is to invest in fixed income products. India will any day give you much better yields.

This explains the absence of debt-oriented global funds.

6. Extremely high-risk funds
Like any domestic equity-oriented fund, the international funds too are susceptible to the market risk. Both stock and commodity markets are highly volatile.

But, as we have seen earlier, international funds also face the risk of exchange rate volatility i.e. currency risk, which is absent in domestic funds.

Besides this, as seen earlier, many of the international funds available in the market have a narrow investment objective e.g. a particular country, a particular geography or a particular theme. This concentration adds to the risk.

Therefore, you should be
a) extremely careful with the funds that you choose, AND
b) limit your total investment in international funds to at most 5-15% of your total portfolio.

7. Extra time to receive redemption proceeds
For domestic schemes, most mutual fund companies will credit your account within 3-5 days of you submitting the redemption request.

International funds take much longer — at least 7 to 15 days — to remit the redemption amount to your account.

So, when you invest in international funds, you must ensure that you provide ample time for the funds to come in. Depending on them, in the matters of emergency, may not be a workable proposition.

Concluding: International funds help you to diversify your portfolio across different economies in the world. Plus, they enable you to take exposure to certain opportunities, that are not available in India. Thus, you must add such funds to your portfolio. However, given the high risk and taxation, you must take only a limited exposure to them.

An Investment In Knowledge Pays The Best Interest ~ Benjamin Franklin

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