There has been a lot of hype regarding diversifying portfolios. People generally think of diversification as spreading horizons across different assets classes in order to manage the risks. Diversification is not a limited concept restricting itself to the allocation of funds across different asset classes but it can extend to diversifying across countries and continents. This is called geographical diversification. Geographical diversification is characterized by spreading risks across geographies.
A majority of investors make investments in their country of residence making them vulnerable to risks a country possesses. In case the economy is not performing well or if there are any negative political events happening in the country, the result is evident in the stock market’s performance as well. Geographical diversification protects against these country-related risks. Mutual funds are one good option to explore foreign markets.
Here are the advantages and disadvantages of investing in foreign markets;
- Portfolio diversification: While you invest in foreign markets, you leverage your portfolio with diversification which is beneficial in getting bigger exposure across the globe.
- Cushioning against risks: Risk mitigation happens due to portfolio diversification
- Unrestricted investments: Investments through foreign funds has not been restricted by the RBI. The overall overseas investment an individual can make is approximately 1.7 Cr.
- Currency movement does not work against the financial plan: If you wish to settle in abroad or plan for your child’s education in a foreign country then investing in foreign funds is highly beneficial as it does not get affected by the corresponding currency movement. For example, the Indian Rupee has depreciated by almost 61% in the last decade. It used to be Rs. 42 against 1 Dollar in the year 2008 while by the end of the year 2018, it has depreciated to Rs. 68. Having a financial budget with investments in foreign funds can help you save for your upcoming foreign expense on the ground zero.
- Exposure to global risk: Apart from being cushioned against the home country risks, the portfolio gets exposed to the other country’s risks in which you have invested.
- Currency risk: While the currency movement does not affect your financial plan, it does have an impact on the portfolio returns. An appreciating Rupee has a negative effect on the returns while a depreciating one affects positively.
- No tax benefits: Foreign funds are treated as debt funds for the purpose of taxation. For investments more than 3 years (long-term investments), the taxation is done at an interest percentage of 20% along with indexation benefit.
There are two ways in which you can categorize foreign funds:
Based on Asset Allocation and Portfolio Construction
- If you are directly investing in foreign funds then you or your advisor need to diligently look for profitable funds. Evaluating the past track of companies would prove beneficial in the selection.
- If you are going for the Feeder Funds which are the funds investing in international mutual fund scheme, you need to track the performance of fund manager who is managing these funds overseas.
- If you are investing through Funds of Funds then you can invest in multiple funds. you need to screen multiple funds in order to invest in foreign funds.
- Another category of such funds are the ones investing around 35% in foreign equities which basically are the domestic funds investing in foreign markets, a minimum of 65% is invested in Indian equities.
Based on investment basket
- Global funds: these are the most diversified funds investing across economies and sectors.
- Thematic and sectoral funds: they are specific to a particular sector or theme like real estate or gold, agriculture, mining, etc.
- Funds specific to the region: they are specific to a region or country. Investors can get exposure to economies like China, Brazil, US, etc.
Before you go for investing in foreign funds, make sure to evaluate all the possible pros and cons and which funds type can be to your maximum advantage. Research well regarding the currency movement and risks.