Should you be Investing in International Equities?

Here are a few guidelines on whether you should be Investing in International Equities:

Should you be Investing in International Equities?Investing in International Equities seems innovative, isn’t it! You may look upon it as one of the means to diversify. Diversification implies allocating your investments in a manner that value of your portfolio remains in line with your return expectations. It entails incorporating such assets in the portfolio which react differently to the particular event.

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Your portfolio is exposed to primarily two types of risks: diversifiable and un-diversifiable. Diversifiable risks are unsystematic risks. These are related to the company, industry or country. You can reduce these risks using hedging. Un-diversifiable risks are systematic/market risks. These are caused by factors beyond the control of the firm like interest rate, exchange rate, political instability, etc. You can’t diversify market risks.

When you diversify unsystematic risks, your portfolio stays buoyant. The overall risks are minimised resulting in wealth accumulation. Ultimately, it helps you to reach your financial goals.

Importance of Geographical Diversification

Suppose you have a portfolio of information technology stocks. Poor quarterly results of a few IT giants could make the IT stocks to tumble. Consequently, your portfolio may lose value on account of such volatility. If, however, you incorporate some FMCG stocks with IT stocks, then the impact may be less severe. It’s because FMCGs have a stable demand throughout the year.

Let’s say the inflation rates shoot up in your country. It may lead to decline in the stock prices of FMCGs due to reduced consumption. Now again the value of your portfolio may erode. So, you need to make your diversification strategy more robust.

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India, being an emerging market, has a relatively volatile market. On the one hand, it provides opportunities to earn higher returns. But at the same time, it makes the portfolio vulnerable towards losses due to unstable macroeconomic factors.

This situation may be countered by investing a certain percentage of your portfolio in foreign markets. It is known as geographical diversification. It involves making portfolio allocations across different geographic regions. It helps to overcome issues related to concentration risks. The concentration of investments in one country is as risky as a concentration in a single asset class.

How to Invest in International Equities

There are two ways to invest in international equities:

1. You may own stocks of a company which is listed on a foreign stock exchange. For this, you need to open an overseas trading account. You may approach any brokerage house in India which has a tie-up with the foreign brokerage houses.

Then, you need to transfer funds to be invested in the broker’s account. For this, fill up A2 declaration form and deposit it in your bank branch. Look for the transaction charges before investing abroad.

2. You may invest in international equity mutual funds that invest in foreign stocks. Some of them are Birla Sunlife Global Commodity Fund, DHFL Pramerica Global Agribusiness Offshore Fund, etc. There are feeder funds like Franklin India Feeder Fund that route money to foreign funds. Apart from that, Fund of funds also invests in foreign funds.

You may invest in these mutual funds by following a simple KYC procedure.

Benefits of Geographical Diversification

1. Opportunities Abroad

Geographical diversification is based on the assumption of weak correlation between financial markets across the globe. Financial markets in developing countries may be in its infancy. So investments may be susceptible to higher risks due to frequent policy changes. But, markets in the advanced nations have considerable depth to absorb shocks and stay buoyant during crises. This low correlation may help compensate unexpected losses in India with stable returns elsewhere in the world. Hence, it’s a means to gain access to lucrative opportunities that are not available in your country.

2. Timing the market

Research has found mean-reversion among the portfolio returns. It means that regional markets may outperform the benchmark in the short run. But it cannot consistently beat the market returns over the long run. Moreover, till now analyst haven’t got a fool-proof strategy to determine which market will outperform in any given year.

In such a scenario, geographical diversification comes handy. When your investments are dispersed across an array of financial markets, it eliminates the need to time the market.

Risks in Geographical Diversification

Undoubtedly, investing abroad has got merits of its own. However, there’s an equal likelihood of loss due to the presence of these risks:

Should you be Investing in International Equities?

1. Currency Risks

In the case of investing abroad, exchange rates come into the picture. Any fluctuations in the exchange rates are accompanied by a change in the value of your portfolio. The risk exposure might go up even without a change in your positions. Suppose you have invested in the US equity markets. Your portfolio would suffer a loss upon appreciation of INR vis-à-vis dollar. It means that lesser number of rupee would be received for the same amount of dollar investments. On the contrary, a weak rupee would escalate your returns manifold.

2. Political Risks

Political instability and geopolitical factors may increase the risk exposure of your foreign portfolio. Business may be interrupted due to wars, civil riots and abrupt changes in government policy. This would impact the profitability of the companies wherein you have invested. Selection of mutual fund should not be based solely upon the rate of return. If a fund promises an exceptionally higher return, there’s a catch.

It might be investing in small-caps or extremely risky regions. Smaller-cap companies are more susceptible to political risks than large-cap ones. Additionally, expatriation of profits becomes difficult in the case of extremely vulnerable regions. You may find it difficult to redeem investments due to an unexpected embargo. If you are investing directly in equities, look for the sovereign ratings for creditworthiness.

3. Liquidity Risks

You might come across liquidity risk while investing abroad. It refers to difficulty in finding buyers for company stocks held by you. In the case of liquidity risk, you may face problems in redeeming the investments when you need them the most. Such kind of risk is found in the case of smaller companies in emerging markets.

You may take help of some indicators to analyse the extent of liquidity risk. Narrow bid-ask spread and higher volumes indicate low risk. Conversely, wider spread and low volumes indicate high liquidity risk.

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Things you need to know

1. RBI has capped the maximum investment in direct equity abroad at $ 250,000 per year. However, there are no such limits for investing in Indian mutual funds which invest in foreign equity.

2. Taxation on dividend received on foreign equities is different from domestic equities. The dividend received from foreign stocks is taxable under “Income from other sources”. The dividend would be included in your total income. It would be taxed as per prescribed income slab.

You may be subject to double taxation as well. It means that initially dividend received is taxed by the foreign government. Then upon expatriation, it’s taxed by the Indian government.

3. The long-term capital gains on foreign equity are taxed similarly to that of debt funds. The rate of taxation is 20%.

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