Investment Avenues in India for NRIs with High Risk Appetite   Oct 20, 2012


Our earlier series must have given you the idea about how India is still an attractive destination for NRI investors. We also have considered asset classes that you can take exposure to. However, before investing in any asset class, as you are aware, you must assess your risk appetite too. We have already discussed the asset classes suitable to risk averse investors. In this piece we would talk about how NRIs with high risk taking ability can invest in India, and which asset classes they might consider attractive.

When you earn in foreign currency and invest in India; you run several risks. Some of them are common across asset classes such as currency risk; while others are specific risks associated with a particular asset class. For example, some assets may show frequent fluctuations in their value therefore investors may lose money, if adequate attention is not given. However, those who carefully invest in such assets stand a chance to generate enormous wealth over a longer run. In that sense these asset classes are risky and hence should only be considered by those who can take some amount of risk to generate superior returns.

There are broadly 2 asset classes available to NRIs who are willing to take risk:

  • Equities
  • Real Estate

Investing in Equities:

Being an NRI, you are permitted to invest in Indian equities. If you wish to take exposure to equities, you have two options. You could opt for the direct route (i.e. invest directly in stocks) or invest in equity oriented mutual funds. For direct investments you may opt for Portfolio Investment Scheme (PIS) run by the Reserve Bank of India (RBI) on repatriable as well as on non-repatriable basis. But for those who aren’t well versed with stock picking; equity mutual funds are ideal. You need not take any prior approval from RBI for taking any of the aforesaid routes. Both options have their merits and demerits. Later, we will discuss them in detail. Before that, let’s understand some nitty-gritties of investing in direct equities (i.e. stocks).

Direct Route

Being an NRI you can invest up to 5% of the paid up capital of an Indian company. NRIs have full access to secondary market; a market where investors transact in stocks. Moreover, you can also apply to Initial Public Offers (IPOs) provided the company that issues shares has complied with regularity norms related to issuing shares to NRIs.

Benefits of investing in Direct Equities…

India has been an attractive destination for investors. Indian equity market offers breadth and the depth as well. By investing in equities directly; you can take exposure to various sectors and companies within the sectors. Moreover you may also invest in companies which are not tracked widely, but offer huge growth potential due to their inherent business strengths. The other advantage of investing in equities directly is that you can take as much exposure to a company as you would like to, provided it is below the prescribed limits set by the RBI.

Many of you now would like to revisit the procedure you need to follow for buying shares of Indian companies.

4 steps to follow to be able to invest in equities directly

  • Open an NRE/ NRO savings account with a bank in India
  • Apply for PIS scheme which only select banks are authorised to approve. On approval; you would open a PIS NRE/NRO account with the bank. It is exclusively used to settle financial transactions happening on account of buying and selling of shares
  • Open a trading and a demat account with an authorised Depositary Participant (DP) registered under Central Depositary Services Limited (CDSL) or under National Securities Depositary Limited (NSDL)
  • Give authorities, wherever necessary, to the bank and the DP to carry out transactions on your behalf

Are there any flaws of investing directly?

There are a few demerits too associated with investing directly in equities. The whole procedure right from opening an account to monitoring investments may look tiresome to you if you are not very investment savvy or simply don’t have time to manage investments on your own. Under such circumstances; many NRIs fall prey to brokers making lofty promises of generating supernormal returns on equities. They may churn your portfolio excessively and earn higher brokerage incomes leaving you in lurch. Besides, you may miss some good investment opportunities, frequent churning may result in higher short term capital gain tax from the 1st rupee of profits you made. If not managed well, you may also suffer a loss of capital. Furthermore, there are some costs associated with investing in equities directly. If your transaction volume is not high enough you may end up spending more of your time, effort and money to get little benefit. You may feel enthused to trade but unless you understand the fine nuances of investing, direct route may not be suitable to you.

At this point, we think it’s important to tell you why mutual funds may be an easy substitute to the direct route.

What is a mutual fund?

A mutual fund is a vehicle that enables a collective group of individuals to

  • Pool their surplus funds and collectively invest in instruments / assets for a common investment objective.
  • Make optimum use of the knowledge and experience of the fund management team
  • Benefit from the economies of scale which the size of pooled investments provide

There are various types of mutual funds investing in the whole spectrum of assets right from debt to gold. There are a few funds which invest mainly in equities. They may follow different philosophies as some of them may focus only on a specific sector or a theme. On other hand there are funds that follow no bias towards any sector which are called diversified funds. While within diversified funds there can be ones investing only in a specific market capitalisation segment say; large cap. There are also some funds which have a flexibility to invest in large sized as well as the smaller companies without any binding. They may follow the top-down approach where the macro economic factors are considered the starting point of the investment or they may follow the bottom up approach where the company specific factors are considered important for investment irrespective of the macros. As this philosophy believes that, companies with strong fundamentals would always put a good show. A few funds may follow a combination of both; top down and the bottom up. It is always better to invest in a fund which follows no sector bias. Besides, investing in a fund that has no market cap bias gives fund manager more flexibility in managing the funds.

As mentioned earlier, if you have profound insight in stock selection and have time to analyse companies, you can surely follow the direct route. However, in absence of any of the pre-requisites you could prefer the indirect route i.e. through mutual funds. Mutual funds offer several important advantages over direct stock-picking.

Advantages of investing in a Mutual Fund

  • Diversification

    Investing in stocks directly has one serious drawback - lack of diversification. You may not adequately diversify the portfolio across sectors and market caps. By putting your money into just a few stocks, you can subject yourself to considerable risk. Decline in a stock can have severe adverse impact on your investments, damaging the returns on your portfolio. A mutual fund, by investing in several stocks, tries to overcome this risk. Typically they hold more than 20 stocks.

  • Professional Management

    Active portfolio management requires not only sound investment knowledge but also considerable time and skill. By investing in a mutual fund, you as an investor do not have to track the prospects and potential of companies in the mutual fund portfolio. This is already being done for you, by skilled research professionals appointed by the mutual fund.

  • Lower initial investment

    For a sum of Rs 5,000 you can’t buy many stocks if you prefer a direct route. However, a mutual fund gives you access to as many as 20-30 stocks with such a small sum. This is an advantage which only mutual funds can give you.

  • Economies of Scale

    By buying a handful of stocks, the direct equity investors lose out on economies of scale. This directly impacts the profitability of the portfolio. If investors buy or sell actively, the impact on profitability would be that much higher. On the other hand, in case of mutual funds, frequent voluminous purchases/sales results in proportionately lower trading costs than individuals, thus translating into significantly better investment performance.

  • Special Features

    Mutual funds offer some special features as Systematic Investment Plan (SIPs), Systematic Transfer Plan (STPs) and Systematic Withdrawal Plan (SWP) etc. which you would otherwise find difficult to employ in your portfolio of direct equities.

  • Liquidity

    In case you need money; you may not know which stocks to sell from your portfolio of direct equities. However in case of mutual funds, you merely need to request a particular sum from your investment and it would be executed. You need not have to think about which stock you need to sell how much to sell. The fund manager takes care of it. It may at times happen that; if you want to sell a large chunk of a particular stock and there are not adequate buyers for that stock on a particular day; you may have to either settle for lower price or then have to stagger your selling; both are inconvenient for you as an investor.

Why Mutual Funds over Direct Equities: Summary
  Who scores better
Parameter Direct Equities Equity Mutual Funds
Diversification Χ
Flexibility
Simplicity of investing Χ
Liquidity
Systemic risk Χ Χ
Costs Χ
Key: "" denotes advantage, while "Χ" denotes no advantage of the parameter

Now that we have discussed why you should invest in an equity mutual fund, it is important to understand that merely investing in a mutual fund wouldn’t serve any benefit automatically. That’s why we believe it is necessary to share a few pointers which may help you select a winning mutual fund.

You should broadly compare funds on 3 criteria

  • Performance
  • Quality of Fund Management
  • Costs

While doing so there can be many aspects pertaining to each of these parameters which have to be carefully assessed. For example, you may go wrong if you give undue importance to recent performance of the fund. Likewise, returns that are generated by frequent churning or by applying trading strategies may not be sustained, as it is difficult to believe that the fund house would time the market on every market move. In other words, you should not only look at the returns but also have to look at quality of returns.

SIP Vs. Lump sum

While investing in mutual funds, you may opt for SIP or the lump sum mode of investing. Under the SIP mode you invest predetermined amount every month on a specified date. This gives you a benefit of Rupee-Cost averaging; i.e. you buy more units when the Net Asset Value (NAV) is low and vice-versa. This is a simple way of investing in a fund as it not only inculcates the habit of investing regularly but also slowly builds your long term wealth, by powering your investments with the compounding effect. Under the lump sum mode you invest at one go an "x" some of money. While there is absolutely nothing wrong with investing lump-sum, you must bear in mind that if you invest when the valuations are very high you may have to wait a little longer to realize any meaningful gains.

How can one invest in a Mutual Fund?

You don’t have to undergo any tiresome paperwork to invest in mutual funds. You need to submit an application along with your Know Your Client (KYC) status proof. Complying with KYC status requirement is a prerequisite for investing in mutual funds in India. The status whether NRI or a Resident Individual is to be mentioned in KYC application. It can also be tracked by the Income Tax Department since it contains your PAN Number. In other words, KYC is aimed at bringing transparency in mutual fund investment. The database is maintained by CDSL.

Real Estate:

Real estate is an alternative asset class that can be considered by investors with higher risk tolerance. NRIs investing in Indian real estate may benefit due to huge untapped demand. There are millions of people who do not own well-built houses. Those who are living in smaller homes have inclination to buy bigger ones. With rising middle class, demand for residential properties would further rise. On the other hand, demand for commercial properties depends on pace of economic development and the level of interest rates. Moreover, the Indian Government has undertaken steps to attract foreign investments in the real estate sector. The revised investor friendly policies encourage offshore investors to own real estate property in India. As a result, investing in Indian real estate is not only rewarding but also reasonably simple.

In the one of our next series we would look at how NRI’s can opt for home loans in India. Until wish you all, very Happy Investing!!



This NRI article has been authored by PersonalFN, exclusively for Quantum Mutual Fund. PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

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