Livemint, Nov 16, 2020
• Indians are taking tentative steps into international stock markets. What are the rewards—and the risks?
• Some experts are also wary of the heightened valuations in the red-hot US markets. Also, while investing in international stocks, picking the right market at the right time is vital
MUMBAI : As the stock market scales fresh peaks with each passing day, some investors are truly reaping the rewards of thinking local and acting global. The top-performing mutual fund in India over the past five years invests outside the country. Motilal Oswal Nasdaq 100 Exchange Traded Fund (ETF) manages ₹1,940 crore of Indian money and has delivered returns of 22.9% since 2015.
In fact, given that the fund has given returns of 23.95% since its inception in 2011, it is likely to be India’s top-performer for the decade as well, lording over Mirae Asset Emerging Bluechip (17.70%).
Ten years ago, investing overseas looked like an offbeat bet—both for fund houses and investors. “When we launched the asset management company (AMC), we wanted to focus on ETFs and passive investing and hence the Nasdaq ETF was part of that," explained Prateek Oswal, head, passive funds at Motilal Oswal AMC. “Invest internationally to reduce risk rather than to increase returns. Also, you get the benefit of rupee depreciation," he added. The fund house launched an S&P 500 Index Fund in 2020 in the middle of the lockdown, a bet that has paid off with US markets continuing to rally in 2020.
While Motilal Oswal got lucky with its offbeat bet, the big mutual fund houses have by and large stayed indifferent. One reason was the foreign investment limit of $300 million per fund house and $7 billion for the industry, set by market regulator Sebi in 2008. These quotas placed limits on how far such funds could be scaled up. To give some perspective, at prevailing exchange rates, $300 million comes to ₹2,217 crore, while each of the top three AMCs have assets in excess of ₹1 trillion. The industry simply wasn’t interested in the small change of international funds.
Responding to pressure from the industry, the regulator doubled the limit to $600 million on 5 November. The new quota is also relatively small for India’s ₹28 trillion mutual fund industry, but it opens up the possibility of future hikes, particularly as India’s foreign exchange reserves have swelled.
International investing has also caught the attention of mid-sized fund houses, with Axis AMC launching its Global Equity Alpha Fund of Funds in September. Others have chosen to open up existing domestic funds to a part international mix, following the path blazed by PPFAS Mutual Fund, a small fund house that has seen explosive growth in the past year. Tata Mutual Fund became the latest in the space to follow this “combo" strategy, amending its scheme documents in October to enable foreign stocks in three of its funds, including an IT sector fund.
In the fund of funds (FoF) category, overseas assets under management (AUM) touched ₹6,496 crore at the end of September 2020, according to data from the Association of Mutual Funds in India (Amfi) and the number of folios has tripled in the past year (as of October 2020).
Does all this set the stage for a big jump in investing overseas? Remember, most Indians have missed the global bus to wealth creation, devoting their attention to the domestic market instead. There’s a reason for that: the domestic market story has been packaged and repackaged to Indian investors based on the slogans set by the government of the day.
During the UPA years, infrastructure was the hot favourite, replaced in NDA I by “Make in India” and post demonetisation by “digital economy”. By the time Indian investors woke up to a decade of 8-9% returns in the domestic stock market, the few people who had bet on US equities walked away with double-digit returns.
More importantly, for those who wish to make bets now, what are the exact risks in investing in global economies that are flush with funds in a pandemic year?
The playing field
Global diversification is a well-established investing concept. It encapsulates the idea that a global portfolio is better protected against country-specific risks such as an economic slowdown or political instability. Investors also get to participate in the profits of multinationals with sales across the world.
India’s share in the global economy varies from 3-8% depending on whether one sees it in dollar or purchasing power parity terms. Hence, the idea of participating in the growth of the balance 92-97% of the world is a self evident advantage. The US in particular is an attractive destination. Its stock market hosts the world’s largest and most successful tech companies, such as Apple, Alphabet (which owns Google), Facebook and Amazon. Another big reason why Indian investors participate in international investing is rupee depreciation against the dollar.
“I started investing internationally because I didn’t want my savings to depreciate with the rupee every year. I invest in the Vanguard Total World Stock ETF because I don’t have any views on which country will outperform. My philosophy is to invest in it and leave it there for the long term,” said Vineet Gupta, 50, a Bengaluru-based investor.
To be sure, a few family offices such as Waterfield Advisors and Sanctum Investment Management have entered into tie-ups to advise on international investing. Family Offices tend to focus on high net-worth individuals (UHNIs) with investible assets equivalent to $1 million and above.
The global options
There are two principal routes in which Indian residents can invest outside the country. The first is via mutual funds. This is a relatively simple, low-cost option geared towards the small-ticket investor. These mutual funds are denominated in rupees and work just like any domestic mutual fund in terms of investment and redemption. Their taxation is also the same as debt funds in India, meaning that anyone who holds for more than 3 years gets taxed at 20% along with the benefit of indexation.
The second route is by opening a brokerage account outside India. Investors can do this by sending money abroad under the Liberalised Remittance Scheme (LRS) of the Reserve Bank of India which has an annual limit of $250,000. The LRS limit opens up a lot more possibilities in terms of stocks and funds that an investor can buy from the limited basket that Indian MFs offer. However transferring money abroad is expensive, requires more paperwork and complicates tax filing for Indian investors, as we explain below.
“International investing through the LRS route is a difficult process because nobody in India advises on the many complex tax issues that come with international investing. I had to do my own research and learn from scratch” said Gupta. International stocks are treated as unlisted stocks and hence taxed at 20% with the benefit of indexation for holding periods over 2 years. For shorter holding periods, gains in them are taxed at slab rate. In case of mutual funds and ETFs, the holding period for long term is 3 years.
The picture of industry indifference is slowly starting to change. A host of startups have brought foreign investing to the masses through tie-ups with large brokerage houses. Two fintechs, Stockal and Vested, are the two early movers in this space with tie-ups with HDFC Securities and Axis Securities, respectively.
“Since our tie up with HDFC Securities a year ago, we’ve added 45 more partnerships including brokerages like Motilal Oswal and Geojit and advisors and wealth management firms. While brokerage clients invest $5,000-6,000 with us on average, wealth management clients show ticket sizes of $50,000 and above. We’ve been doing around $5-6 million new AUM a month in 2020 on average and this remains intact even after TCS was imposed in October," said Sitashwa Shrivastava, founder, Stockal.
From 1 October, a 5% tax collected at source (TCS) went into effect on foreign remittances above ₹7 lakh. The tax can be set off against tax on other income tax due and even claimed back as a refund if excess tax is collected, but it acts as a large upfront cost for Indian investors.
“Yes, retail investors are transferring low amounts, but that is compensated for by growth in the number of investors. In terms of transactions, I would say our investors are doing $40-50 million in cash trades every month,” Shrivastava added
Vested Finance, a US SEC-registered financial adviser reported 30,000 accounts and a growth of 70% in accounts in the second quarter of FY 2021, as India gradually reopened from a lockdown. Mutual Fund fintechs such as Kuvera and discount brokers like Upstox have also ventured into the space, once again through tie ups. Zerodha remains the only large player waiting in the wings.
While US markets have created enormous wealth for the small band of Indian investors, this has not been the case with other stock markets such as Europe or emerging markets like Brazil.
Some experts are also wary of the heightened valuations in the US markets. The dizzying rise of US stocks has sparked caution among some experts. “We have felt like the US has looked expensive for some time and we still think so. The fundamental performance of US stocks has surprised us on the upside. I think it has surprised a number of investors,” Daniel Needham global chief investment officer (CIO) of Morningstar told Mint recently.
“If we look at what’s baked into the price of the S&P 500 at 3,000, we think companies are going to struggle to meet expectations. The US has some of the best companies in the world but what matters is the price you pay for them. We have been early on the US call,” he added.
The US markets have risen significantly since last year, with the Nasdaq rising about 50% in rupee terms (as of 10 November), strengthening concerns about overvaluation. “The Nasdaq ETF returns have been great but I’m not sure that you should expect the same 20-25% CAGR in the next decade,” warned Oswal.
Vikas Gupta, CEO, Omniscience Capital, a Sebi-registered investment adviser, took a more nuanced position. “There are instances of bubble-like valuations in stocks like Tesla or Netflix, but this is not a generalised problem in US tech stocks,” he said. “If you compare price to cash flows, the Nasdaq 100 is actually cheaper than the Nifty 50. There is still plenty of room for them to grow. Valuations don’t even factor some of the disruptive bets of these companies. Google’s self driving cars for example can upend the automotive market,” he added.
China, meanwhile, is an outlier. It figures marginally on the Indian investor’s map but Indian mutual funds investing in it such as Edelweiss Greater China Offshore Equity Fund have delivered a strong performance (CAGR of 15.08% in the last decade). Clearly, picking the right market at the right time is vital.
In addition, international investing operates under the glare of official disapproval, particularly when it is done through the LRS route. Apart from the recently-introduced TCS, foreign investments have to be reported every year under Schedule FA of the Income Tax returns and omissions can bring the investor under India’s stringent black money law.
In addition, foreign countries such as the US collect their own withholding tax on dividends and these need to be claimed back from India under the Double Taxation Avoidance Treaty (DTAA), adding another layer of form filing to the exercise.
To be sure, the mutual fund route does away with all these issues for Indian investors. How quickly will an industry labouring under a spate of outflows grab this opportunity?