Pros and cons of investing internationally

Indians were allowed to invest in international equities some 17 years ago (around 2003). Imagine having bought any of the top tech American companies then. Adjusted for dollars, you could have easily made a tiny fortune by now. But no one took advantage of that. And why would they? If you had a gourmet chef at home, would you eat out? It was the case with the Indian economy back then.

The Indian economy and by extension, the stock markets were doing very well around 2003, prompting investors to invest in their home country. It was also the time where terms like BRICS and India Inc were thrown around, further boosting investor morale. Even the rupee was appreciating against the dollar, eliminating any need for Indian investors to seek returns outside their home country.

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But even now, most people refrain from investing internationally. Why invest elsewhere when our own country is to expected to outperform, they argue. While I too was of a similar opinion, it dawned on me that this is not entirely true. Mainly as, over the long-term, there have been several instances when the US stock index has outperformed the Indian stock index (adjusted for currency fluctuations) and vice-versa.

I realised that there is an apparent lack of synchronicity between the Indian and international markets i.e., they are not co-related. And that is a great mark of diversity amongst assets, something that every investor yearns for. Moreso, investing internationally gives you access to nearly all global leaders from different fields. You can invest in Apple, Microsoft, Amazon, Nike, Alibaba, Visa, Procter and Gamble, Tencent etc.

Imagine having invested in any of these stocks, combined with the dollar returns.

Source: Yahoo Finance

Investing in international stocks is not just about returns

But just because every other top brokerage firm is foraying into international investing, it does not make its the new mantra to generate that extra bit of alpha in your portfolio. Neither does it guarantee any stable returns. All it does is reduce the risk in your portfolio by diversifying your investments. And if you think about it, it makes perfect sense.

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Every economy is in a different stage of development with its local triggers for growth and slowdown. So for some local reasons, if your money lying in one part of the world does not do well, you still have some in the other part doing just fine. Therefore, investing in international markets is a great diversification tool, where your primary reward is lowered volatility (more stable returns) and your risks are:

• buying the stocks of a country you do not have first-hand information on. It makes picking the right market at the right time one of the significant drawbacks investors face. With the US, Europe and China being the primary markets for international investing, choosing the right stock market at the right time can be tricky.

• the currency risk, where an appreciating home currency (in our case the Indian Rupee) or a depreciating foreign currency, can eat into your returns.

• investing international stocks requires you to abide by a set of rules and comes with certain limitations, that can be cumbersome to follow; like an upper limit on investments, taxation etc.

Some critical aspects of international investing that every investor must bear in mind:

How much can I invest in foreign stocks?

While there is no minimum ticket size to invest in foreign stocks, there is an upper limit.

International investing, effectively involves remittances of funds which falls under the Reserve Bank of India's scheme referred to as the Liberalised Remittance Scheme (LRS). Under this scheme, Indian residents are allowed to remit up to $250,000 to any country in a given financial year.

What's important is that this amount is not just for investments. It applies to all remittances made by an individual in a financial year and includes education, travel, medical treatment and investments (except derivatives and leveraged products). So to use the entire amount for investments, ensure that you have not already exhausted your limit.

At the end of the financial year, the investor submits a declaration stating that your total amount of remittances are well within the annual limit.

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What are the transaction costs?

Every brokerage firm follows a different cost structure. They can charge you:

an annual subscription fee plus charges for every transaction or

a fixed transaction fee, either in absolute terms ranging from $0.8-$6 per transaction or in a percentage form.

So while comparing firms, ensure that you factor in all costs incurred (annual fees and transaction charges).

Investors often ignore transaction costs, forgetting that even a small per cent can grow exponentially, eating away at your returns. So, the key is to choose a platform that not only optimises your returns but also minimises your trading costs.

Keep in mind that when you buy directly, currency conversion, brokerage and transfer charges easily take away 2-4% of your investment value. Whereas, mutual funds charge you anywhere between 0.25-2% (expense ratio).

So, if you have a relatively small portfolio, opt for investing via Indian mutual funds investing internationally. They are far more economical and easy to manage than buying foreign stocks directly.

But, if you have a larger portfolio, investing directly in stocks makes more sense. It widens your choice and gives you access to markets other than the US, which mutual funds do not offer at the moment.

How are capital gains on foreign stocks taxed?

Capital gains from investments in foreign stocks and capital gains from investment in funds are taxed differently. The qualifying period for the long-term investment in stocks is two years and three years in the case of funds.

Capital gains within three-years are considered short-term, taxed at your prevalent slab rate whereas,

Capital gains after three-years are considered long-term, taxed at 20%.

Dividend from international investments is taxed at your prevailing slab rate. But in the event of a tax deduction at source, you can claim the benefit under the Double Taxation Avoidance Agreement.

A common question amongst investors is how much of their portfolio should be exposed to international stocks. A simple solution is to link the proportion of their international exposure in stocks to any future liabilities in foreign currency. And a classic example is of parents who intend to send their kids to the US for further education.

A recent survey revealed that nearly 40% of HNI's (High Networth Individuals) expenses are in foreign currency. Now, this can also be a good starting point. Nonetheless, if stocks are a part of your long-term portfolio, you must consider allocating a small proportion (10-20%) of that to international stocks mainly to facilitate diversification.

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