Forum Views, Mar 3, 2022
Volume:10 Issue No. 12
Bombay Stock Exchange Brokers’ Forum (BBF)
In the age of the globe-trotting Indian, it would seem appropriate that Indian investment portfolios reflect this international character too. And, whilst this has not been the case historically, things do appear to be moving in this direction albeit it is still early in the game. In this article, we look at the evolution of international investing for Indian investors and the growing list of options available to them.
Indian investors have historically exhibited a strong home bias, which is the tendency for portfolios to be heavily, or even entirely, concentrated in home market investment instruments. This has been due to a range of factors including an inherent preference for what is familiar, and limitations of capital, opportunity, and awareness. In fact, investors across the world exhibit this bias in their portfolios too. This goes against one of the most elementary principles of risk management, which is diversification. According to Forbes, even in countries such as the US, only 15% of equity portfolios comprise international equities. In India, that number is much lower.
A small piece of a large pie
By restricting themselves to India, investors are missing an opportunity to invest in global leaders, diversify across geographies, improve return potential, and stabilize portfolio returns. International investing also includes themes and asset classes that are not available domestically. India makes up about 3% of the global equity market capitalisation and about 8% of global GDP (PPP adjusted). Only seven out of Fortune Global 500 companies are Indian and none is in the top twenty. Additionally, each country has different strengths and opportunities. The US is known for innovation, Germany for engineering, China for low-cost manufacturing and now, innovation. Having a global portfolio allows one to capture the strengths of each geography.
When it comes to diversification, which remains the bedrock of prudent risk management, it’s useful to note that the correlation between the Nifty 50 and S&P 500 is less than 0.5 and lower still when compared to emerging markets.
If we were to expand this table to include other asset classes like fixed income and real estate, and add currencies to the mix, the results would be even more stark. Further, the Indian currency has been depreciating against the US dollar by about 3-4% annually due to a range of structural factors, and this could continue. Hence, aside from growth in the underlying asset’s value, any foreign investment would automatically grow by 3-4% annually in rupee terms due to currency appreciation alone.
Coming back to home bias let us look at the underlying factors in more detail.
Investors feel familiar and comfortable with investing in local markets. Many are not aware of the international options available to them or do not think they have the wherewithal to analyse foreign investments. Additionally, Indian equities have delivered strong returns historically and hence investors have not felt a need to look for other opportunities.
Other hurdles include a lack of full currency convertibility which has led to administrative complexity and size limitations. In 2004, the RBI had introduced the Liberalised Remittance Scheme (LRS) under which resident Indians could send money abroad, but the limit was set at USD 25,000 only. In 2015, this increased to USD 250,000. While this led to a rise in outward remittances, the bulk of them have been for studies aboard, travel, maintenance of close relatives, and gifts. According to RBI data, out of USD 12.7bn of outward remittances under the LRS in FY21, only USD 0.48bn was for equity and debt investments although this too has been growing over the last few years.
Tax treatment of foreign investments is another issue. For example, until 2018, local equities did not have any long-term capital gain (LTCG) tax, while global equities via feeder funds were taxed like debt funds – LTCG of 20% with indexation after 3 years – although this gap has reduced somewhat with the introduction of LTCG for domestic equities in 2018. Investments via the LRS are taxed as unlisted equity at 20% with indexation after 2 years.
Transferring money in and out of India can be an expensive affair too. Banks could charge 2-5% as a spread on the exchange rate, often with a commission on top. These costs have reduced over the years yet remain high and a deterrent to sending money abroad.
All things are difficult before they are easy
Not withstanding the limitations, we have come a long way over the last few years. Today, there is a growing appetite and an expanding universe of options for domestic investors to invest abroad.
The simplest and most effective way is to invest in Indian domiciled international funds, feeder funds, and ETFs. Investors, especially high-net-worth individuals, have latched on to these over the last few years. The number of funds has almost doubled to more than 60 from 31 in 2018, and their AUM has increased 20 times to about INR 40,000 crores from about INR 2,000 crores in the same period. In fact, these funds have stopped taking fresh subscriptions as they are close to breaching the USD 7bn limit set by RBI back in 2008, another structural limitation that we expect policy makers to revise soon. We now have funds that cover a large investible universe with many country and region-specific, thematic, and sectoral funds that could help construct a well-balanced global portfolio.
While feeder funds are the easiest way to invest globally, and do represent ultimate exposure to foreign currencies, they are denominated in INR from an investor’s standpoint. Therefore, they do not serve the purpose of those who need USD balances and wish to build a portfolio in it directly. For them, the LRS route is the only way out, which can be cumbersome.
That said, in the last couple of years investing using LRS has also improved drastically. Many brokers have tied up with international platforms and now allow investors to buy global stocks. Also, new fintech platforms have made it extremely easy to invest globally in a cost-effective way.
Further, the Indian government has set up an international finance centre called the Gujarat International Finance Tec- City (GIFT City). GIFT City enables resident Indians to make offshore investments and non-resident Indians to make onshore investments. The National Stock Exchange (NSE) has set up NSE IFSC Limited as an international exchange in GIFT City. This will enable resident Indian investors to buy select US stocks with the intention of increasing the universe gradually. The NSE IFSC has tied up with certain preferred banks to reduce the conversion costs to as low as INR 50-150 and a spread of not more than 0.5% to remit money via the LRS route. Additionally, these stocks are fractionalised to reduce the minimum investment amount required to hold certain stocks. This will make foreign stocks accessible to average retail investors. Similarly, the BSE has setup up India INX for buying and selling international equities.
The GIFT city also allows resident individuals with a minimum net worth of USD 1 million in the previous fiscal year to invest in Alternative Investment Funds (AIFs) in GIFT City. These AIFs can pool money from resident individuals to invest exclusively in overseas investments. Currently, there are more than ten such AIFs and more are expected over the next few months. Other new products are under development in GIFT City too.
While we have seen a sharp growth in international investment in the last few years, we have barely scratched the surface. The overall AUM in locally domiciled funds that invests in global equities is only about 3% of overall equity MF assets-under-management. Similarly, of the overall outward remittances, less than 5% are for investments into equity and debt. Also, most Indian investors have concentrated on investing in the US, which has delivered strong returns over the last 10 years. While the US does make up close to half of the global market cap and hence deserves allocation, there is scope and opportunity for investing in many more markets to achieve optimal diversification.
Asset allocation – the secret sauce of successful investing
Opinions vary on the optimal level of international assets in a balanced portfolio with some suggesting an allocation as high as 40-50%. These opinions are based on the principle that most people are even more heavily concentrated in their home markets than is readily apparent once you include physical assets, businesses, and professional income sources. However, given the current stage of evolution, we believe, that 10-15% of the portfolio may be a more appropriate starting point. We also suggest diversifying this allocation across countries and asset classes and not focusing on just the US and equities.
As always, when constructing portfolios, we recommend that investors pay attention to the core principles of asset allocation and diversification. We also suggest they do in- depth research or seek assistance from advisors to help them navigate the growing multitude of options that are available to them.