Is investing overseas a good idea?

After a long Durga Puja break, Jai and Veeru decided to meet up at the neighbourhood dosa joint.

Jai: How have you been, Veeru? Missed you during these Puja holidays. But I was so glad not to be checking the papers or TV channels and worrying about breaking news.

Veeru: Yes, boss! This has been a good month to switch off. First, there was the panic about IL&FS defaulting on bonds and running up Rs 91,000 crore in debt. Many people thought it was a government entity. But now it turns out that it's a strange animal that nobody owns. Then we had the panic about NBFCs finding it difficult to raise money, with their stocks tanking by 30-40 per cent in just a few sessions.

Jai: Absolutely! After looking at my portfolio returns in 2018, I am kicking myself for not investing in international funds. Some of these foreign funds are up by 23-24 per cent in one year. But my Indian multi-cap funds are down by 6 per cent in the same period. Don't even ask about small- and mid-cap funds!

Veeru: That's unfair, Jai. You are comparing one of the worst times for the Indian market and the rupee with a great time for the US market and the dollar. Had you checked on January 1st this year, Indian multi-cap funds had a 40-50 per cent return, but even the best international funds had one-year gains of 16-17 per cent.

These international funds make money when the rupee depreciates and the rupee's down by 13 per cent against the dollar this year.

Jai: I get your point. But then, just think when the Indian rupee has not depreciated against the dollar? In end-2007, we used to exchange one dollar for Rs 37. In December 2010, it was Rs 44 to a dollar. By end-2013, it became Rs 62 to a dollar and now we are at Rs 73! So, it makes a lot of sense to invest in funds that gain from the rupee's weakness.

Veeru: That's quite right. The rupee has fallen against the dollar in 13 of the last 20 years. So, if you can own a fund that benefits from this trend, that's good.

Jai: The only thing is choosing a good international fund is not easy. Fund houses give you so many choices that your head spins. It's like that dosa outlet which makes 73 different types of dosas, including schezwan and mushroom-cheese, and we stop going to it because it confuses us so much.

Veeru: Ha ha! Exactly! I have made this mistake in international funds.

Some 10 years ago, there was all this talk of a commodity 'super cycle'. So, I bought global commodity funds, thinking I will rake in money when oil goes to $200. But it has given me a 5 per cent annualised return. Then, six years ago, there was this buzz about gold stocks and I bought gold-mining funds. Those have been a disaster and are in the red. My plain-vanilla multi-cap funds have got me a 15 per cent annualised return during this time.

Jai: Yes, I confess I have also been sucked into these fancy international themes. I bought some emerging-market funds and found they did worse than Indian funds when the markets tanked. But I have been doing some research on this. I think the international funds that have the most consistent track record are the US equity funds, with a five-year annualised return of 12-13 per cent.

Veeru: Why is that so, I wonder.

Jai: Simple. You buy international funds mainly because you want to benefit from the phases when the rupee is depreciating against the dollar or the stock market is suffering FII pull-outs. Now, I have seen that these big phases of turmoil are usually caused by global cues.

When US interest rates rise or the US dollar strengthens or the US economy is booming, that's when these FIIs rush out of Indian stocks like a bat out of hell. But when this happens, FIIs pull out of all emerging markets and not just India. So, in bad times, other emerging markets tend to behave a lot like India. Hence, it's a double whammy to own both Indian funds and funds investing in emerging markets.

Veeru: Yes, whereas the US market is the perpetual safe-haven choice for global investors. Even if a crisis begins in the US, like the housing crisis, everyone flocks to the dollar and US treasuries, and pulls out of markets like India. We Indians think of gold as the ultimate safe haven. But it is the US dollar which is the even safer haven!

Jai: Yeah, but I see another good reason for investing in US equity funds. The US stock universe is among the largest and most attractive in the world. We Indians are increasingly splurging our money and time on brands like Apple, Amazon, Google, Facebook, Netflix, Revlon or Harley Davidson. But none of these companies are listed in India. We still have a lot of old-timers in oil and gas, IT, steel and FMCG. So, buying a US equity fund is a great way to gain from consumer spending on new-age businesses and brands.

Veeru: That's true, but one must not go overboard with international investing. In the long term, stock prices are a slave to earnings. And earnings in a country like India, which is growing at 7 per cent, will definitely grow faster than in an economy like the US, which is growing at 2 or 3 per cent. In the US, exceptional companies may grow at 10 or 15 per cent. In India, they tend to grow at 20 per cent plus!

Jai: But it is a good idea to own, say, 10 per cent of your portfolio in US equity funds for diversification. They do well when our local equity funds are sinking. Take Franklin India Feeder US Opportunities. It's given a 19 per cent return on a year-to-date basis this year (as of October 24), while multi-cap funds are down by 11 per cent.

Veeru: Yes, the only problem is that investing through this feeder-fund route is not great. You pay double the costs and don't get equity tax benefits also.

Jai: Hey, no, that's no longer such a big disadvantage. SEBI has recently capped the total expense ratios of feeder funds, including their underlying schemes, at the same levels as for equity and debt funds.

Yes, international funds don't get treated as equity funds for tax purposes. But after the recent 10 per cent long-term capital-gains tax on equity funds, the tax difference between international funds and equity funds has shrunk.

Veeru: I didn't think of that. Today even domestic equity funds are subject to long-term capital-gains tax after one year, at 10 per cent. If I hold international funds for three years, I need to pay a 20 per cent LTCG with indexation. In any case, who buys equity funds with a less than three-year horizon? So taxation is no longer a reason to avoid feeder international funds.

Jai: Ultimately, though the reason to invest in US equity funds should not be high returns or taxation but simply diversification from some of the risks of the domestic stock market.

Veeru: Right on! For the same reason, I'd also say that one shouldn't rush into these funds today because they're outperforming domestic equity funds. It's always tempting to invest in any new category after it has shown great short-term performance. But later you find out that was the worst time to invest in it!

Jai: Hey, that's a good warning. I was going to make just that mistake. I'm going to start a long-term SIP in US equity funds with 10 per cent of my savings.