Will overseas funds see a revival after budget relief on capital gains tax?

In Budget 2023, all mutual fund schemes that invested less than 35 percent in equities were put under this category.

Indian mutual fund schemes that invest in overseas markets may again come back into focus after Budget 2024 changed the definition of ‘specified mutual funds’ for which long-term capital gains (LTCG) and indexation benefits were abruptly removed a year ago.

In Budget 2023, all mutual fund schemes that invested less than 35 percent in equities were put under this category. While the intention was to strip debt funds of LTCG and indexation benefits, other funds such as international funds, gold funds and gold exchange–traded funds (ETF) were also caught in the crossfire. These funds, too, met the definition of a ‘specified mutual fund’.

Budget 2024 has clarified that ‘specified mutual funds’ now mean a fund that invests at least 65 percent of its assets in debt and money market instruments. This brings other funds back under the spotlight.

And for those who wish to invest in foreign securities, overseas funds have regained their appeal.

Setup of international funds

Following the Covid-19 outbreak, Indian mutual fund investors poured into international schemes, which delivered stellar gains thanks to the global tech rally. However, in the past two years, international funds lost a bit of their charm.

In the two years between January 2020 and the end of January 2022, assets under management (AUM) of funds investing in international stocks and ETFs jumped 10-fold, from Rs 4,220 crore to Rs 42,632 crore. During the same period, the total scheme count of overseas funds also nearly doubled from 34 to 60.

This momentum came to a halt when the Securities and Exchange Board of India (SEBI) in January 2022 asked mutual fund houses to stop accepting fresh investments in schemes dedicated to overseas stocks. This was because the industry as a whole was close to breaching the $7-billion limit available to them for investing in overseas securities.

Budget 2023 dealt another blow by removing long-term and short-term provisions for capital gains tax calculations.

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Data available with industry analysis firm ACE MF showed that since February 2022, the AUM of overseas funds grew by just 30 percent till the end of June 2024, while the scheme count went up from 60 to 77.

Back in demand?

Experts say that the taxation relief is a pleasant surprise for investors wishing to invest in international stocks via mutual funds.

“We have received many calls from advisors and investors who remain excited about investing in international funds again. Unfortunately, most funds are still closed for investors, including Motilal Oswal MF, where we are currently only open for SIPs (systematic investment plans),” said Pratik Oswal, chief of business, passive funds, Motilal Oswal Asset Management Company.

Rushabh Desai, founder, Rupee With Rushabh Investment Services, is also of the opinion that the inflows should come back after the changes to capital gains taxes in the budget.

“There is good awareness about international funds, especially after 2020. The amount of flows, however, will depend on the relaxations on the overseas investments limit available to the mutual fund industry,” he said.

The mutual fund industry at present does not have enough foreign remittance limits to be able to accept investor flows. The industry has made several representations to the Reserve Bank of India (RBI) and SEBI to increase limits but so far not much has changed in over two and a half years.

“We hope limits are raised so mutual funds can offer these products to their investors. Limits can be calibrated to ensure no excessive flows are moving out of the country via mutual funds,” said Oswal.

Which funds are open?

While SEBI limits on overseas funds remain in place, the capital market regulator has allowed mutual fund houses to accept fresh investments whenever there is headroom available.

Data compiled by Moneycontrol shows that some of the top overseas funds based on AUM are accepting fresh investments, although with restrictions.

India’s biggest overseas fund, Motilal Oswal Nasdaq 100 ETF (AUM of Rs 7,988 crore) is only open for basket creation by market makers. In simple words, this means that market makers (brokers who fund houses appoint to create liquidity in the stock market for retail investors to buy and sell ETF units) can exchange the underlying basket of stocks in exchange for units and vice versa.

Even major funds such as Kotak Nasdaq 100 Fund of Fund (FoF), Mirae Asset NYSE FANG+ETF FoF, HDFC Developed World Indexes FoF and Navi Nasdaq 100 FoF are not accepting fresh investments.

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On the other hand, schemes such as Franklin India Feeder, Franklin US Opportunities Fund, ICICI Prudential US Bluechip Equity Fund, Edelweiss US Technology Equity FoF and PGIM India Global Equity Opportunities Fund are open for both SIP and lump-sum investments.

What should investors do?

There are various categories of overseas funds available in the market. From the US technology funds to US diversified funds, from China and Brazil to the ASEAN region, overseas funds have delivered varied returns over the years.

While the US technology funds have been among the best of the lot, China-focused funds have delivered disappointing returns over the past three years. Experts suggest staying with diversified US funds, like those based on the S&P 500 index, for a favourable risk-reward ratio.

“You have funds focused on Europe to Brazil to China to emerging equities. You have all sorts of funds, but India itself is an emerging market. For emerging equities exposure, we do not necessarily need to go to other markets. The geographical diversification is best achieved by US-based diversified funds, especially, S&P 500 kind of funds, as a Nasdaq-based fund would be a technology-heavy scheme,” said Amol Joshi, founder of PlanRupee Investment Services.

Kunal Valia, founder, StatLane, a SEBI-registered research analyst also believes that while the global allocation funds have a lot many ideas from emerging markets to including single-country funds like China and Japan, largely, the money will be flowing towards US-centric funds.

“Emerging market funds, largely on the account of China, have not done anything in the last decade or so. Even developed markets (ex-US) have underperformed the US markets. Coming to choosing funds outside of the US, one will have to be more country-specific rather than buying emerging markets as a basket because Chinese equities (which have the maximum weight in the EM basket) are yet to deliver consistently while other countries within EM often offset each other. So, if you want to choose, start with the US, and if you want to diversify, pick single-country funds rather than buying the entire EM as a basket,” Valia said.