Does it Make Sense to Invest in Offshore Funds?   Nov 05, 2018


According to the Central Depository Services (India) Ltd. (CDSL), FIIs have pulled out Rs 55, 610 crore from equity markets in Financial Year (FY) 2018-19 so far. Although, Domestic Institutional Investors (DIIs) have pumped in over Rs 83,100 crore in Indian equity markets, incremental flows have become difficult to come by.

Has India become an unattractive investment destination for Foreign Institutional Investors (FIIs)?

Yes, perhaps.

The falling rupee (INR) has been a concern for Indian investors throughout this financial year. The Federal Reserve (Fed) in the U.S. hiked up interest rates and has hinted at continuing this strategy even in 2019. As a result, emerging market currencies, including the INR, have weakened.

Many investors prefer to invest in offshore funds because of the rupee depreciation and on-going downtrend in the markets. Among them, US-centric diversified mutual fund schemes have generated an impressive 16%-25% over last one year.

Only U.S. focused funds have done well…

 

Absolute (%) CAGR (%)

Scheme Name

1 Year 2 Years 3 Years 5 Years

ICICI Pru US Bluechip Equity Fund(G)-Direct Plan

25.6 22.8 15.3 13.3

Reliance US Equity Opp Fund(G)-Direct Plan

22.0 21.7 14.7  -

Franklin India Feeder - Franklin U.S. Opportunities Fund(G)-Direct Plan

21.6 22.6 12.5 13.1

DSP US Flexible Equity Fund(G)-Direct Plan

21.0 22.7 14.4 13.5

Kotak US Equity Fund(G)-Direct Plan

16.9 18.7 12.4  -

Edelweiss US Value Equity Offshore Fund(G)-Direct Plan

15.8 14.4 10.2 10.1

NIFTY 50 – TRI

2.7 12.8 10.9 12.2
Data as on October 31, 2018
(Source: ACE MF)
Sector and thematic offshore funds have performed miserably despite the rupee depreciation in the recent past. Except US-centric funds, the average return generated by other offshore funds is just 5.2% over the last one year.

Basically, you can’t take offshore funds for granted even when the INR is falling.

So, if you are keen on offshore funds at this juncture, you are betting on two factors:

  1. Global markets will outperform Indian markets

  2. Currency-adjusted returns could be positive for Indian investors if they invest in offshore funds

Just remember, you can’t rely on these factors. Here’s why…

Over the last few months, other Emerging Markets (EMs) have fallen more than Indian markets in dollar terms, reflecting the resilient outperformance of Indian markets. This has led many pundits and investors to opine that when they recover, EMs will outperform the Indian markets.

Is it advisable to choose offshore funds over domestic funds?

The answer is no! It’s not an “either/or” choice between Indian mutual fund schemes and offshore funds. It’s more about diversification.

The pertinent question: Do you have adequate exposure to Indian markets?

If yes, then you may invest less than 10% of your equity assets in offshore funds.

Be very cautious and consider the factors that will negatively affect your investments in the offshore funds. Any major economic, political, ecological, financial shock that affects the overall economic landscape of major global economies will have an impact on every market across the globe.

Here are the risks involved in investing in offshore funds:

  • Country specific macro-economic risk

  • Currency fluctuation risk

  • Change in regulations and policies risk

  • Geopolitical risk

Offshore funds may perform miserably if rupee appreciates

On 02 November 2018, INR recorded its highest single-day gain over the last five years by appreciating 1.4%, nearly 100 paisa against Dollar.  Crude oil traded at its 7-month low on the same day.

If the trend of falling rupee and rising crude oil prices reverses, the Indian economy will benefit. Can this be a good enough reason for FIIs to get back to markets?
It could be.

And if the foreign investments inflows improve, not only will Indian markets rally but the rupee will further appreciate as well—denting the prospects of offshore funds.

What if economic growth in India picks up unexpectedly?

After all, it’s been a decade since we witnessed a capex boom in India. It is highly possible that we might experience a capex-lead boom in India at a time when the capex cycle in major global economies have peaked out already. The low market correlation quotient doesn’t have to work against India’s potential just because its currency has depreciated 13%. 

The reasons are fluid. For instance, crude oil prices might fall; inflation might not rise as much as expected; and Indian export recover fast thereby propping India’s deteriorating current account position.

Tax laws are unfriendly for offshore funds

Any equity mutual fund that invests less than 65% of its assets in Indian equities doesn’t classify as an equity fund for taxation purposes. Therefore, if you invest in an offshore fund investing more than 35% of its assets overseas, you might lose out on the taxation benefits.

If you sell your investments within three years, you will end up paying short-term capital gains tax (STCG) as per your income tax slab. If you hold the investments for more than three years, you will be able to claim the indexation benefits.

In this case, the crucial question is can you take a call on currency movements over the next three years? It doesn’t make sense to invest in an offshore fund that has invested 65% of its assets (to qualify as an equity fund) in India because it defeats the purpose of diversification.

What you should do?

Invest in in offshore funds only if there’s no other option left for you to invest in India. Only a handful of investors will meet this criterion.

Are domestic diversified equity funds a bad deal?

Certainly not, especially if you think the Indian economy has a bright future, invest in it.

Moreover, invest in mutual funds depending on your financial goals, risk appetite, and investment horizon. Shift your focus from macroeconomic trends such as market correlation, rupee depreciation, etc., simply because you can’t accurately time the markets.

When you invest as per your personalised asset allocation, you will tend to make better financial decisions.

Is the stock market volatility deterring you from investing in India-focused domestic mutual funds?

You can invest in equity mutual funds through Systematic Investment Plan (SIP) route to take advantage of rupee-cost averaging.

The most important aspect is that the selection of a mutual fund matters the most.

P.S.: Do you want to know how to select a winning mutual fund?

Watch this video…

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