07 Nov 2016 13:52 IST

Globe-trotting, with equities

It’s a good idea to seek out stock market opportunities abroad even when the Indian market is buzzing

Had you bought shares of the ubiquitous Google (now Alphabet) five years back, your money would have more than doubled by now. An investment in the Facebook stock would have more than tripled in this period. That’s a neat annualised return of 20-30 per cent. But these shares are not listed in India and you have to look beyond the borders to invest in them.

Thankfully, the Reserve Bank of India (RBI) allows this. Under its Liberalised Remittance Scheme, resident individuals may remit up to $2,50,000 in each financial year for permitted capital and current account transactions. These include investing in equities abroad.

But why must one seek overseas opportunities when there is so much promise in Indian equities? There are some good reasons.

Diversification and niche plays

The first is diversification — a core principle of portfolio management that helps reduce overall risk.

Not all global markets do as well or as badly at the same time. In calendar year 2015, for instance, while the Sensex fell 5 per cent, the technology heavy Nasdaq index in the US gained 6 per cent. In 2014 though, the Sensex had raced much faster than most global indices (see table, “Not in lockstep”). While the Indian economy is no doubt better positioned than many others, there is no certainty that this will always continue. So, having your eggs in a few baskets can help shield your portfolio from volatility in a single market and improve overall return.

Next, there are unique listed opportunities abroad that are not available in India. For instance, companies at the cutting edge of technology such as Alphabet (Google), Facebook, Apple and Amazon. If you want a piece of this pie, there is little choice but to look abroad. Also, the stocks of many foreign companies — with good growth prospects — trade much cheaper than Indian ones. From food majors such as Kellogg Company (trailing price-to-earnings of 20 times) to industrial manufacturers such as 3M (21 times), several stocks abroad quote at tidy discounts to Indian peers and subsidiaries (Britannia Industries - 49 times, 3M India - 71 times).

Besides, having foreign currency-denominated investments may be a good idea if you foresee their use in the future — say, to fund your child’s higher education abroad or to buy a house in a foreign country.

Risks and restrictions

Investing abroad, however, entails higher risks and may not be for everyone. For one, the information asymmetry could be high. Investing in equities can be complicated and comes with the risk of capital loss. This is more so in the case of international equity where you may not have access to the latest information and research about the foreign economy, industry and company. Keeping abreast of the happenings that impact your foreign investment is essential to mitigate this risk.

Next, you have to deal with currency risk while investing in international equities. That’s because your rupees get converted into a foreign currency while investing and vice versa while redeeming. If the rupee appreciates during this period, you lose and if it depreciates, you gain. For instance, over the past five years, with the rupee weakening about 35 per cent against the dollar, investments in US stocks would have gained additionally to this extent. But adverse currency movements, which can never be ruled out, could dent price gains on the foreign stock.

Currency risk can be managed by hedging with the use of instruments such as futures, forwards and options. This needs some know-how, though, and may not be easy for the common retail investor. Also, it does not make sense to hedge the currency risk if the investment in foreign currency is earmarked for some future purpose such as your child’s higher education.

Make sure to be on the right side of the law, both Indian and foreign. While the RBI allows Indian residents to invest in financial securities including equities abroad, there is a bar on leveraged offerings such as margin products. Stay away from these.

Through brokers is one route

There are two broad ways you can invest in foreign stocks — the do-it-yourself mode through a broker or via the mutual fund route.

A few Indian brokers such as ICICI Direct, SMC Global Securities and Religare Securities have tie-ups with brokers abroad to facilitate overseas investment for their customers. ICICI Direct and SMC Global Securities have tied up with Denmark-based Saxo Bank while Religare Securities has an arrangement with Bahrain-based Mubasher Financial Services. You can also open an account directly with foreign brokers such as Interactive Brokers and Saxo Capital Markets.

To open the overseas account, you must submit the account opening form to the broker along with KYC documents including identity proof and residential proof. Account opening charges could range from ₹1,000 to ₹1,500 at local brokerages. Then, you have to transfer funds from a local bank to the overseas account after submission of a few documents, including Form A2, an application cum declaration form, and a FEMA declaration form. A minimum initial deposit equivalent of $5,000 or more may be required, though there may be no need to maintain this on a monthly basis.

You can then buy and sell stocks on the online platform of the overseas broker. Investments are allowed across multiple geographies and markets. While the account can be opened in one foreign currency, say, the US dollar, you can invest in other markets too, subject to currency conversion charges.

Brokerage rates vary with the country and exchanges. For instance, transactions in the US market usually entail a flat per trade brokerage while those in European and Asian markets are charged as a percentage of the transaction value. Also, there are generally minimum charges for transactions. For instance, ICICI Direct-Saxo Bank’s commission rate for transactions on the US exchanges is 2 cents per share with a minimum commission of $15 each order. For London Stock Exchange transactions, the commission is 0.14 per cent of the order value, subject to a minimum £8 an order. There are other charges too, such as custody fees for the securities.

Going with an international broker directly rather than routing through a local broker may work out more cost-effective since it would mean one less layer of intermediation. Says Ankit Shah, Director of Sales at Interactive Brokers (India) Pvt Ltd, “Other local brokers in India that provide access to global markets have tied up with foreign brokers, so yes, there would most likely be an additional layer of cost involved.”

Interactive Brokers charges half a US cent per share with a minimum of $1 per order and minimum brokerage fees of $10 a month. Saxo Capital Markets charges 1 cent per share with a minimum fee of $9.9 per order. Active traders with a certain minimum number of trades get competitive brokerage rates.

Check rates and other charges offered by various players; it is possible for some local brokers to have global relationships with international brokers which could translate into lower cost due to high volumes.

When you are investing through a broker, you are essentially taking your own calls on the stock and taking on currency and other risks. So, do your homework well. Rudra Dalmia, formerly CEO of Saxo Bank India, says, “It is important to have knowledge about the specific security being purchased and the currency being invested in. Half-baked knowledge is dangerous and can lead to losses. Read international investment websites, research well and then start trading.”

While selecting a broker for international trade, check out the entity’s credibility, financial position and strength, the products and markets being offered, the cost of transacting and transparency, and the sophistication of the trading technology being used.

Through mutual funds

If all this sounds cumbersome, you can consider the mutual fund route to get exposure to foreign stocks. There are three ways to go about this. Through your international broking account, you can buy units of exchange traded funds (ETFs) or mutual funds listed abroad. Next, you can go for India-based feeder funds (for example, Franklin India Feeder Franklin US Opportunities Fund) that invest in funds abroad, or in India-based funds that invest largely in international stocks (for example, ICICI Pru US Bluechip Equity Fund). You can also put money in local funds that invest a part of their corpus in foreign stocks — this category includes funds such as Parag Parikh Long Term Value Fund and Templeton India Equity Income Fund.

The performance of these various funds has been mixed over the past few years (see table “Global Funds - a mixed bag”). That said, investing in foreign stocks through a local mutual fund saves you the trouble of opening an overseas broking account, doing the research before investing, taking on various risks and minimum brokerage commitments.

Investing through an India-based mutual fund can also be more cost-effective and tax-efficient. Funds that invest at least 65 per cent of the corpus in Indian stocks are categorised as equity funds; investors in such funds do not have to pay tax on capital gains if the units are sold after holding for at least one year.

Gains on direct investments in foreign equity or in foreign listed mutual funds will be subject to capital gains. Also, dividends in such cases will be taxed in the investor’s hands both abroad and in India, unlike dividends declared by India-based funds which are exempt from tax in the investor’s hands. Also, mutual funds, being institutional clients with large volumes, will likely get favourable rates on brokerage, currency conversion and other charges on their global stock dealings.

On the flipside, like in any other mutual fund, you incur expenses including fund management charges that eat into returns. Also, you do not have the flexibility of selecting stocks, but have to go with the fund manager’s choice.

If you have a large corpus, seek flexibility in choices and asset classes, and have the wherewithal to research your investments, opening an account directly with a foreign broker will be worthwhile. Else, the India-based mutual fund route to investing in foreign stocks seems the better option.