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Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Invest in MFs, save on upfront costs

Investing in equity and debt markets via the MF route is the way to go.

For Indians staying outside their country, investing in Indian funds makes a lot of sense. Here’s how to make the most of your investments. Investors worldwide suffer from a home-country bias, which prevents them from adequately investing in countries outside of their residence and Indians are no different. Estimates suggest there are about 25 million Indians living in countries outside of India (non-resident Indians, or NRIs) and these NRIs annually remit about $50 billion to India (as per data from the Reserve bank of India). The reasons for the remittance could be quite diverse, ranging from buying a house to sending money for parents and dependants. Many non-residents also invest in Indian capital markets directly via stocks, initial public offers (IPOs) or mutual funds (MFs). As it is for most hands-off investors, investing in equity and debt markets via the MF route is the way to go to take exposure to the financial market.

Investing in India has a lot of advantages for NRIs. You get exposure to not only India’s high-growth economy and superior market performance (stocks have logged about an annualized 18% return over the past 10- and 30-year periods, fixed-income yields have historically remained high, currently hovering in the 8-9% range) and also get to diversify your capital across economies.

Local or offshore?

NRIs have two options to invest in India via the MF route—to invest in India-domiciled rupee-denominated funds or dollar-denominated offshore products that invest in India. There are many regional/global companies that offer India-focused offshore funds which directly invest in the Indian markets.

The treatment for an India-domiciled MF versus an offshore fund that invests in India is different, from operational as well as tax standpoints, something that I will come to later.

First, should you have a preference between the two? Analysis from Mercer shows that in the past and over three- and five-year time periods, local Indian funds outperformed their offshore peers which invest in India. And intuitively it would make more sense as an on-the-ground fund manager with more local knowledge would be better placed to take investment decisions than someone who tracks it from outside the country.

One crucial benefit of investing in local funds over offshore India-focused funds is the upfront sales charge. India-domiciled funds do not carry a sales charge after the regulator banned entry loads a few years ago, but offshore funds tend to carry a high entry load. Our database shows that the initial charge in the case of some of the large offshore India funds are in the range of 5-6%.

Taxation laws for investors abroad who invest in India-domiciled funds are the same as those for resident Indians (15% short-term capital gains tax and nil long-term capital gains tax for equity funds) but unlike resident Indians, tax is deducted at source.

If India has a double-taxation avoidance agreement with your local country, you will avoid paying tax on repatriation of funds. Conversely, if your country follows a more liberal taxation regime (Singapore, for instance) compared with India, an NRI investor can choose to invest in an offshore Indian fund domiciled in that country. Do not, however, choose to prefer an offshore fund over a local Indian fund only to get a preferential tax treatment.

Foreign currency risk

Your fund’s fortune will also depend on the way the rupee is moving but the risk will manifest itself in different ways for both local and offshore Indian fund, albeit remaining the same for both investments.

For, a Singapore-based NRI who invests in an offshore Indian fund, the investment is made in Singapore dollars and the fund company converts it into Indian rupees to invest in the Indian markets. Any movement in the rupee will directly impact the offshore fund’s net performance. However, when you invest in an India-domiciled fund, you have to convert your dollars into rupees. The rupee risk will emerge and stay on till you redeem and convert your money back into dollars, though it would not show up in the local fund’s performance.

Investing in India: know the course

Investing principles remain the same whether you are investing in India or abroad. Asset allocation and risk profiling are of utmost importance and these should drive your fund choices. While selecting any fund, focus on the fund manager, track record, investment strategy, quality of the fund company and keep an eye on the fund’s fees. A fund is as good as the fund manager and the investment process it follows, so follow a bottom-up approach and evaluate each fund whether local or offshore on its own merits.

Finally, keep in mind that the Indian market can be notoriously volatile and is higher-beta compared with a lot of markets globally. In the past 22 years since 1991, the BSE Sensex has logged over (+/-) 20% annual return in 14 out of 22 occasions with the best gain of 91% in a single year (1991) and worst return of -52.45% (2008) and tends to react sharply on both the upside and downside.

Such high volatility requires a higher level of conviction from an investor though it could be rewarding for those who hold on for the long run, as it has been for patient investors in India.

Aditya Agarwal is managing director, Morningstar India.

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