Should Young Investors Invest in International Mutual Funds?

As a young investor, you’re most likely shopping on Amazon, connecting with your friends and family on Facebook, using an iPhone, and using Gmail. There may be a question in your mind about how you can profit from the immense growth potential of these companies.

Welcome to International Mutual Funds which precisely allow you to do that. This article provides you with a complete lowdown on these funds and whether it makes sense for young investors like you to invest in them.

International mutual funds are Indian funds that invest in the stocks of foreign companies. They do it in either of the following ways:

• Investing directly in stocks of foreign companies
• Investing their money in one or multiple foreign funds, which in turn invests in these companies (known as feeder investing)

From the perspective of investing approach, we can classify these funds into the following types:

• Country/Region-Specific: As the name suggests, these funds invest in companies from a specific region or countries like the US or Europe, or Africa. Some examples are ICICI US Bluechip Fund (invests in US companies only) and Franklin Asian Equity Fund (invests in companies across the Asian region)
• Theme/Sector Specific Funds: These funds pick a theme or sector and invest in companies that fall into those themes, irrespective of the geography where it falls in. Examples include ABSL Global Real Estate Fund and DSP World Mining Fund.
• Global funds: These funds diversify themselves across markets, themes and geographies. An example is ICICI Prudential Global Stable Equity Fund

Now let us look at the benefits of investing in these funds, which are as follows:

• Investing in these funds help you to diversify your risk and bring down the total risk of your portfolio. This is because there is little correlation between the equity markets of India vis a vis other countries.
• Companies like Amazon, Google, Facebook, Apple, Nestle, Boeing, Alibaba, etc., are not yet listed in India. These funds allow you to profit from the growth potential of these well-managed global companies.
• Over the years, INR has depreciated around 3-4% every year against USD. Investing in these funds helps hedge currency depreciation. It is a good option for those investors who have USD denominated goals like children’s higher education in the US.
• These funds allow greater depth to your portfolio. They do that by helping you invest in sectors that are not easily covered by Indian mutual funds like aviation, defence equipment, gold mining etc.

You also need to keep in mind certain downsides of these funds as follows:

• You expose yourself to the risks of Indian and other countries/geographies that you’re invested in through these funds. By diversification, your risk only gets spread out. It does not get extinguished.
• Due to higher brokerage and fund management costs, these funds carry a higher expense ratio than Indian equity funds.
• Income from these funds is taxed as debt funds in India. This means that any income within 3 years is taxable as short-term capital gain as per your income slab. Long term capital gain is taxable at 20% with indexation benefit.

The first thing to note is that it is not a must to invest in these funds. Suppose you are starting out in your investment journey. In that case, it is a better approach to ignore these funds and focus on aspects like asset allocation, goal-based planning, etc.

Over time you may start doing focused goal-based planning, and your investment portfolio will also increase through regular investments. It is then that you can consider adding these funds for your long-term financial goals. Take care to keep it simple and not include more than 2 such funds in the portfolio. You can also tag the same fund to multiple financial goals by investing in separate folios.

Some other points as follows:

• Don’t go overboard on these funds, especially if your goals are due to mature in INR. Try to have a maximum allocation of 25% of the portfolio’s equity portion in these funds. If the goal is a USD-based goal like a child’s higher education, only then should you consider a higher allocation to these funds.
• Amongst the funds, it is better to stick to a larger and sophisticated USD-based economy like the US. The reason is that given the strength of USD, a currency hedge against USD is much more potent as compared to other currencies.
• While selecting a fund, do check if it is consistently able to beat the index benchmark. Also, check the expense ratio. If a higher expense ratio bothers you, you can consider ETF. You will need to have a Demat account for that.
• Try not to make any tactical allocations to profit from short term movements in these funds without deep knowledge.

As investors are becoming more aware of international markets and the potential of large international companies, they are attracted to international mutual funds. And due to this, the market for such funds is evolving in India at a good pace. It is a better approach for young investors to move step by step and take exposure in these funds for the right reasons and at the right time. Also, one should pay careful attention to the dynamics of these funds and their effect on your investment portfolio.