What are International Mutual Funds? Are They Recommended?

International Mutual Funds are usually preferred by those investors who want to invest in securities beyond domestic stocks and across geographical barriers. 

International Mutual Funds invest in the stocks and shares of companies outside the investor’s home country. In case of India, it would be funds that invest in the equities of companies that are outside India. They are also referred to as Foreign Funds. Investors usually invest in International Mutual Funds to diversify their portfolio, take advantage of the stock market rallies on major stock exchanges across the world and nullify the impact of stock market volatilities at home. 

Schemes under International Mutual Funds

There are three sub-categories under International Mutual Funds category:

* Domestic-International Hybrid: This invests 65% in domestic equities and balance 35% in international equities. In case of the Indian investors, this is a good option because Indian markets are doing rather well presently and returns from these investments become tax free after one year. Funds like Birla Sun life International Equity Fund balance the portfolio between domestic and international investments. 

* Feeder Investments:  This invests through “feeder” route into a particular country or region. Under this mechanism, the fund invests in another international fund, which in turn invests directly in foreign stocks. For example, Franklin Feeder US Opportunities Fund, which invests through this mechanism in the stock of companies listed in the USA.

* Thematic Investments: This invests in stocks with an underlying theme based on sector and industry. A simple example of thematic international funds is DSPBR World Agriculture Fund which invests in stocks and companies related to the agricultural sector outside India.

Advantages of International Mutual Funds

Investment in International Mutual Funds has the following major advantages:

* Hedge: They act as a hedge against the fall in the rupee against dollar, thus minimizing losses owing to the currency depreciation.

* Diversification: These funds diversify the portfolio of investors and give them access to the markets that otherwise would be difficult, thereby reducing exposure to the Indian stocks. 

* Balance economic volatility: Investment in mutual funds of numerous economies can help investors to ensure healthy returns by overcoming the economic cycles. This modus operandi nullifies the losses of economic volatility plaguing some of the investments by profiting from better performing economies

* Track record: Most underlying stocks that constitute a particular International Mutual Funds scheme have a credible track record and sufficient information about their past performance. This enables the investors to take a sound and informed decision.

* Access to foreign blue chip companies: Some corporate giants like Royal Dutch Shell, Google, Microsoft or cola companies do not have their shares listed on Indian stock exchanges. In such cases the only way of investing in their shares is through international mutual funds or direct investment.

Risks Associated with International Mutual Funds

With all the advantages that International Mutual Funds have, there are definitely some risks involved with them:

* Currency fluctuation: The major risk with International Mutual Funds is the currency fluctuation. You are investing in rupees, but then it is converted into various currencies, depending on the country where it is invested. If the foreign currency in which you have invested falls in value against the rupee, then your returns will suffer and reverse the gains you may have made in the market.

* Economic and political factors: Mutual funds are subject to market risks and this is why their performances are directly linked to the economy they operate in. Foreign funds suffer from political and economic risks of their region and keeping abreast of such developments is not easy for a foreign retail investor. By the time you make a withdrawal to void losses, it might be too late.

* Slowdown in foreign economies: With India being one of the fastest growing economies in the world, investments are giving double digit returns here whereas very few international funds have show this kind of appreciation. Also, there is a general slowdown in foreign economies, particularly Europe and to some extent the US too. In such a scenario, investing in low growth foreign funds should be considered carefully. 

* Liquidity crunch: As compared to the mature foreign markets (for example, the US and UK) which absorb the volatility better, the developing economies (for example, Brazil and Indonesia) may not be able to do so. The developing economies may face liquidity crunch making it very difficult for the International Mutual Fund investor to sell investments and exit.

* Limited information: The funds specifically fed through feeder mechanism may give very limited information on the underlying stock which is a big risk as the investor cannot gauge the safety of investment in such cases.

Taxation of Returns on International Mutual Funds

The returns on International Mutual Funds for the taxation purpose are treated just like domestic debt funds as they do not qualify for equity funds. The gains from units held for less than three years are added to the person’s income and taxed according to the Income Tax slab. If the holding period is more than three years, the investor can avail the indexation benefit. After indexation, the gain is taxed at 20 per cent.

Should You Buy International Mutual Funds?International Mutual Funds are definitely not recommended for amateur investors. If you are a mature or high net worth investor who has already exhausted domestic equity market, then you may consider investing about five to ten percent of total mutual fund portfolio in the International Mutual Funds. 

However, the investment should be done only if you are ready to undertake currency fluctuation risk, and after cautiously scrutinizing the said scheme as well as political-economic factors of the country.

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Pratik Sarawogi
Pratik is an MBA from IBS business school – Mumbai, with dual specialization in Marketing and Finance. He is driven by passion for markets and loves to analyze client portfolios with a long-term approach. He believes in the principle of asset allocation and diversification to maximise client return following a risk-based approach. Managing risk comes naturally to him, owing to his prior work experience with worked for ICICI Prudential Life Insurance Co. Ltd.

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