It refers to our tendency of investing only in companies which are listed within the country we live in. This usually occurs because we are comfortable investing in names that we are familiar with.
A few other reasons why we resist investing in companies listed abroad:
Lack of time / ability to conduct adequate research before (and sometimes, even after) investing.
Fear of losing money due to currency fluctuations.
Being overwhelmed by the wide choice of options.
Unfriendly Capital-Gains tax laws.
Cumbersome procedures involved in the transaction process.
Is there some solution which could help you invest abroad without encountering some of these hurdles ? Yes...Mutual Funds.
Mutual Funds offer various options for investing in foreign equities. More about these a little later...First, let us revisit a few basics:
What is a portfolio in the context of mutual fund investing?
To put it simply, it is a diversified collection of stocks and / or bonds invested in a certain proportion, in accordance with a particular mutual fund scheme's stated investment mandate.
What is 'diversification'?
It involves a deliberate attempt to restrict the proportion of a certain asset / asset class in the portfolio so as to reduce the risk of capital loss due to adverse developments in any particular one. Hence, if you like the adage, “Do not put all your eggs in one basket”, consider investing in mutual funds.
How does one diversify?
While this depends on a scheme's mandate, broadly, an equity fund could diversify by investing in stocks of companies of varying size, in different industries and in different geographies. The exact proportion will depend on the judgement of the individual fund manager.
How can you, the investor, attain such geographical diversification?
It could be undertaken in two ways:
At the portfolio level:
For instance you may own five mutual fund schemes, two of which are purely international funds. Such funds could be in the form of:
Global Feeder Funds: While such schemes are launched in India, they invest / feed their entire corpus into another existing international scheme, often from the same fund house. Sometimes, such feeder funds also invest into broad-based international indices (Eg. S&P 500, NASDAQ 100). There is no active fund management involved in such schemes.
Global Thematic Funds: Such funds invest in a specific theme / sector globally. Global mining / energy / gold / agriculture funds are examples of these. They may either be in the form of feeder funds or actively managed funds. While they do offer exposure to varied geographies, they face the risk of investing only in one theme. Hence, they often have the same upside and downside of a sector / thematic fund, investing in the home country.
At the scheme level:
Here, such diversification is offered within a scheme itself. For instance, it may invest 65% in Indian equities and upto 35% in equities listed abroad. Hence, the investor is able to benefit from diversification without increasing the number of schemes in the portfolio.
How does geographical diversification help?
1. Reduced 'concentration' risk:
While investing in companies across sectors and size in the home country helps, the benefit may be negated in case there is a crisis which affects that country as a whole. This may be in the form of natural calamities, political events, runaway inflation, etc.
Also, many times, global stock-markets do not move in tandem or at least do not move together in the same degree. In other words, the correlation between global stock-markets is not constant and winners vary from year to year.
Each year a different market is a winner
Source: Value Research
Please note : The above table only illustrates past performance. It is virtually impossible to forecast in advance as to which country's stockmarket / stocks will perform the best.
Investing abroad does not guarantee that a scheme will always invest in the best performing stockmarket at any given point in time. However, it certainly reduces the risk that investors face on account of investing exclusively in their country of residence.
2. Broad-based exposure:
Investing abroad, helps Indian investors to gain access to high quality businesses which are not listed over here. For instance, companies such as Google, Coca Cola, Mastercard, etc.
3. Better valuations:
Sometimes, the domestic subsidiary of a multinational company, may be richly valued in the home market. In such cases, purchasing the stock of the parent may be more appropriate. Eg. The Indian subsidiaries of Nestle and 3M are valued more richly as compared to the parent, listed abroad.
4. Country of listing may only be incidental:
Gloablisation has ensured that a large proportion of a company's earnings may accrue in countries other the country of listing. For instance, banks such as HSBC and Standard Chartered. Hence, it is possible to have an exposure in fast-growing markets, even if the stock is listed in a slower growing one.
A few downsides...and how to mitigate them:
1. Currency risk:
As the investments are conducted in a foreign currency, domestic investors' returns could be hurt due to adverse currency fluctuations. However, this effect could be stripped out if the fund manager hedges the currency exposure (say, through exchange traded currency derivatives) at the outset.
2. Unfavourable tax treatment:
Currently, one must remain invested in international funds for a period of 3 years, before they are treated as long-term assets. Even after that, they are taxed at the rate of 20%. However, this hurdle is obviated in the case of schemes which invest a minimum of 65% in Indian equities. Such schemes are treated as long-term assets after a holding period of only one year, and no long-term capital gains tax is payable if the investment is redeemed after that period.
3. Higher expense ratios:
This may happen in the case of Feeder Funds, who are permitted to charge an amount (usually 0.25% to 0.50%) over and above those charged by the underlying scheme. However, investors choosing to invest in diversified schemes which invest a portion of their corpus in international equities, do not have to bear this additional burden.
In a nutshell, it is prudent for Indian investors to consider schemes investing in international stocks. Also, after considering the downside involved with feeder funds and thematic funds, it may be a good option to choose a diversified equity scheme which straddles both, the home and overseas markets.
Please note: All companies / indices / mutual fund schemes mentioned above are for illustrative purposes only. They do not amount to any recommendation on our part.