How you can invest in international markets

One way investors can diversify their investments is by allocating a part of their portfolio outside the country. However, many popular mutual funds in India with international exposure are closed to new subscriptions due to regulatory limitations.

In February 2022, the markets regulator directed asset management companies to stop accepting fresh inflows into international mutual funds because the industry had exhausted the overseas investment limit of $7 billion set by the Reserve Bank of India (RBI).

The Securities and Exchange Board of India (Sebi) has allowed new investments in international schemes, but only to offset redemptions.

Each AMC had a $1 billion overseas investment limit. However, if XYZ AMC had $600 million invested overseas when the industry breached the $7 billion limit in 2022, then that became its new upper limit. If any redemption occurs and the international exposure comes down to $400 million, then the AMC can accept inflows of up to $200 million to offset the shortfall.

There are 61 international mutual fund schemes, showed data from BSE Star MF. Of those, 31 funds are closed for lump sum investments and 32 for systematic investment plans (SIPs).

Most funds that invest in the US are closed to new investments as their investment quota has been breached quickly due to high investor demand.

Combo funds

If investors want to diversify into an international market but are unsure how to do it, they can consider funds that hold a mixture of domestic and global equities. Funds like Parag Parikh Flexi Cap Fund and DSP Value Fund have exposure to both international and domestic securities.

Schemes with at least 65% in Indian equities are taxed at 20% if sold within 12 months and 12.5% if sold after 12 months. International schemes are taxed at 12.5% after 24 months and at a slab rate if sold within 24 months.

“It’s difficult for investors to maintain a fixed international exposure through mutual funds, as most funds have already exhausted their overseas investment limits. This makes it challenging to allocate incremental inflows towards building or maintaining global exposure,” said Arun Kumar, head of researchatonline mutual funds investment and stock trading platform FundsIndia.

Kumar said he prefers having a separate fund for international exposure. However, if the fund is sold, tax has to be paid, whereas churning by fund managers inside a combo fund has no tax incidence.

Sahil Kapoor, head of product and investment strategist at DSP Mutual Fund, said they still have room to accept international exposure and can maintain the current ratio of international to domestic positions even if they receive fresh inflows. DSP Value Fund currently has 30% exposure to international stocks and exchange-traded funds (ETFs).

One should not paint all international investing with the same brush, said Nirav Karkera, head of research at Fisdom.

He said investors should be aware of the sectors and geographies they’re taking exposure to. For instance, he said, having exposure to a US index and a Brazilian index might mean two completely different things.

International ETFs

International ETFs are traded in stock exchanges. However, experts warn that many of these ETFs are trading at a premium to their underlying.

Motilal Oswal Nasdaq 100 Fund of Fund Direct Growth gave a one-year return of 56% as of 19 December 2024, while Kotak NASDAQ 100 Fund of Fund Direct Growth returned 25% despite both the funds tracking the NASDAQ 100, showed data from investment research firm Value Research.

This happened because the Motilal Oswal fund had Motilal Oswal Nasdaq as its underlying. The ETF was trading at a big premium to its underlying, as the regulatory quota halted fresh investment, but investor demand kept rising. On the other hand, the Kotak fund was feeding into the iShares Nasdaq 100 UCITS ETF, which is traded in global markets and was trading at its fair value.

“Whenever the overseas investment limit gets revised upwards, the present premium will disappear, and so investors in such ETFs need to be very careful of the premium that they’re paying,” said Kumar of FundsIndia.

International ETFs have an overseas investment limit of $1 billion. As the industry limit was nearing, Sebi directed funds holding overseas ETFs as underlying to stop accepting fresh inflows from April 2024.

Alternative route

Investors can use the RBI’s liberalized remittance scheme (LRS) of $250,000 to invest directly in foreign stocks and ETFs. However, experts say it comes with its own set of challenges like increased costs, currency conversion charges, and complicated tax compliance obligations.

“Investors trying to find alternatives to the RBI-imposed cap by using the LRS can consider direct investments in overseas equities. However, this route also poses challenges, including high costs and complex tax compliance. As a result, investors find themselves in a tough spot until the RBI eases the restrictions—something unlikely in the near future given the pressure on the rupee,” said Abhishek Kumar, a registered investment advisor and founder of SahajMoney.

Gift City is another option retail investors can explore. Recently, Mint reported on 3 July that DSP launched India’s first outbound retail fund. The fund was launched on 2 June and has a ticket size of $5,000. The Gift City structure sidesteps the need for cumbersome tax filings and high brokerages as compared to investing overseas using a foreign brokerage account. The fund will invest in 30-50 global companies across markets such as the US, Europe, Japan, South Korea, China, and Canada.

Kumar from SahajMoney said such a retail fund structure might provide a good opportunity for retail investors to diversify internationally, going forward, until the RBI revises the cap on overseas investment limit for the mutual fund industry.