How to invest in international equities

In recent weeks, the International Funds invested through mutual funds (MF) route has come into news as an old regulation has turned hurdle now. Securities Exchange Board of India (SEBI) directed fund houses to halt fresh inflows into fund schemes which allocate abroad. An earlier regulation stipulated, over a decade back, had limit of $7 billion and was triggered as the current allocations are breaching this figure. This is restricted to the funds that allocate either directly into foreign equity or act as feeder fund i.e., fund-of-funds. The ETF route is still open as it has a separate limit of $1billion in allocations.

This has put a wedge in the investor's plans though the existing commitments of Systematic investments (SIP/STP) are allowed but hampering any fresh allocations. This is coming at a very important juncture when the markets have corrected by a great degree and long-term investors view it as an appropriate time to average. This was a risk that wasn't factored by any at the time of investment.

In the globalized and connected world, we tend to experience products or services of many companies which are not listed in India and investors looking to take part in their businesses have the option of using international funds to get an exposure. Of course, the other alternative is to use the LRS (Liberalized Remittance Scheme) where investors in their personal capacity could use up to $250,000 per annum to explore investing abroad. This rule applies to all resident individuals.

This limit includes the fund that's sent abroad for children's education and/or their expenses, etc. The concern in this option is the cumbersomeness i.e., the complexity of operating a demat account which allows the transaction to take place and the costs of executing the same. Moreover, one must be very sure of which stock to pick, etc. while this is mostly nullified in an international fund. Like any regular domestic active management fund, these funds are managed by qualified professional fund managers, transparent allocations and at a cost which could be lower than the direct investing route.

International funds do offer a good source of diversification for investors who are mostly exposed to the domestic assets. These funds do add flavour to the portfolio and offer variety along with a good diversification to the portfolio. The exposure to these funds would provide an automatic way for the investor to ride on the benefits of multiple economies. While International funds and Global funds are generally used to convey the essence, they're different in the way they operate. The former invests in securities across the world excepting the investor's resident country while the investment of the global funds includes the securities of the investor's resident country. This subtle difference should be noted.

Within these funds there could be sector specific funds like technology, agriculture, etc. or thematic funds like innovation, ESG, etc. and the rest would be diversified funds. The common risks for all funds are currency related i.e., the change in Rupee valuation against US Dollar. In case of rupee appreciation, the NAV decreases as one realized lesser number of rupees and vice versa. However, one of the popularities of these funds in India other than the increased awareness is the foreign exchange arbitrage these funds gained in the last few years. The rupee has been depreciating consistently vis-à-vis the dollar and it has given a natural addition to the returns. Moreover, the US stock market performance in the last decade has been better than the Indian bourses which generated better returns.

Another important risk factor is the country specific change in the social, political and economic sphere which have a great bearing on the performance of the fund. Investing in emerging markets offer better growth prospects than developed markets but have less developed finance, legal, regulatory and political systems that could lead to higher risks. Moreover, any change in these factors could lead to next order repercussions which can't be easily fathomed.

For instance, during the latest conflict between Ukraine and Russia, there has been a near unanimous boycott of Russian institutions by the Western countries. While the war has brought huge volatility into the market, the moves to contain Russian assets has eroded all the value making them un-investable. The MSCI (Morgan Stanley Capital International) emerging market index has a 1.5 per cent weight for Russia and cutting off from the index could hurt the investors leading to larger exodus of funds.

The current SEBI impasse is temporary and would be resolved soon for the investors to commence investing in these funds. Investors should be aware of the possible risks, though not all cascading effects could be comprehended. The exposure, hence, should be curtailed to a proportion that suits the risk appetite with a better understanding of the risk/reward metric. Also, it's better to opt for a diversified fund than a region specific one or a sectoral/thematic fund unless the investor is sure of the risks.

(The author is a co-founder of "Wealocity", a wealth management firm and could be reached at [email protected])