All the fuss about foreign equity investments
Updated: Sep 28, 2021
Investment in global equity was considered fad that only deep pocketed high net worth investors could indulge in. However, various platforms such as Stockal and INDmoney allows foreign stocks to be bought in fractional units which helps retail investors diversify into global equity.
Moreover, in the current scenario, where one cannot rule out the possibility of a prolonged slowdown in the domestic market, it makes sense to hedge the portfolio by investing some portion in foreign markets having strong growth prospects.
Indians have progressively increased their usage of global products and services in the past few decades. However, still today around 0.4% of total AUM of Indian mutual funds account for global stocks. It is big time that average Indian investor included global stocks in its portfolio.
Things to be considered before investing into foreign equity
Impact of Forex movement
Foreign exposure is even more necessary for investors who anticipate future expenses in foreign currency (for e.g., child’s fees at a foreign university). For such investors, the India only portfolio represents unhedged risk to a declining rupee, whereas investment in foreign equity is simply a hedge rather than an exposure.
The foreign exchange impact on global investments cuts both ways. If the rupee strengthen against the currency, it will curtail your returns. However, the forex movement will mostly work in favour of Indian investors.
Geographical diversification helps as there has been significant variance in 3 and 5 year returns of US and Indian Markets. However, UK markets have lagged due to Brexit
Source: In.investing.com, FBIL
Selecting foreign equity market
While selecting destination for investment, investments shall be made only in most developed economies and where market regulation is solid and legal systems provide strong protection against malpractice. Emerging countries shall be avoided as they could pose additional risk such as China wherein information standard is poor and disclosure standards are questionable. Others like Turkey have tenuous balance of payment situations due to which its currency poses unacceptable risk to investors.
Pros of global investing
Diversification is the most apparent yet the most vital gain in global investing. A diversified portfolio acts as a source of stability during market volatility. When you spread out your investments throughout geographies, there may be a low correlation among them. Which means the volatility in one marketplace is likely no longer to affect your other assets.
Wide range of investment options
Economies like the US are home to some of the world’s largest tech companies – something you cannot access by investing in India. You may even select a theme or a combination of multiple sectors. For example, you can prefer the US market for technology, Europe for engineering, and Australia for commodities. If you are interested in healthcare or pharmaceuticals, there are several options in the US and Europe.
Developed market companies often have strict rules that ensure healthy corporate management and serious penalties for market abuse. This protects retail investors from potential campaigns and internal trade losses.
Investing overseas exposes you to currency appreciation (or depreciation). However, emerging markets’ currencies depreciate over the longer-term. By investing globally, portfolios have generally had the dual benefit of better markets and appreciating currencies.
Cons of global investing
Higher Transaction Costs
The most significant barrier to investing in global markets is the added transaction cost, which varies depending on the foreign market you want to invest in. However, platforms such as Stockal and INDmoney provide low-cost brokerage.
Apart from price fluctuations in stock price, investors are also prone to currency fluctuations. However, currency of emerging markets depreciates over time, which work in favour of Indian investors.
While investing, you should also consider the geopolitical environment of the country. Political events affect the domestic markets of the country and may lead to volatility. In emerging markets, government and policy decisions could hurt even the most prominent companies. We have seen this frequently in countries like Brazil and Argentina.
Mind the tax compliance
Investing abroad requires certain tax compliances and different tax rates. Make sure you comply with tax rules relating to foreign assets to avoid falling foul of tax rules.
Disclosing foreign assets in tax return
Most important thing to note is that if you are a tax resident of India, you are required to disclose all foreign assets and foreign income in your income tax return (ITR). Even if there is no income, the assets must be declared in the return even if assets are held at any time during the year. Also, filing of ITR is mandatory for those who own foreign assets even if their total income from all sources is below minimum exemption limit of Rs.2.5 lakhs.
Taxation in India
If stock listed in foreign bourses is held for more than two years, the gains from the sale are treated as long-term capital gains, which are taxed at 20% after indexation of cost. Exemption of Rs.1 lakh per year, which is available on sale of shares in India, is not available on foreign stocks. If held for less than two years, the gains are treated for short-term capital gain, which shall be added to income of the investor and is taxed at the applicable slab rate.
Avoiding Double taxation
Foreign residents are exempted from capital gains tax in most countries, including US and UK. Whether you make short-term or long-term gains on stocks you don’t have to pay tax in that country. However, dividend income shall be received net of withholding tax which shall be further taxable in India. For e.g., ordinary resident in India holding stock listed on NYSE receives dividend (net of withholding tax) shall be taxable in India as it is neither exempt as per Income tax Act 1961 or as per India-USA Double Taxation Avoidance Agreement (DTAA). However, tax paid on this dividend in the US can be claimed as credit in India while filing ITR by filing form 67 online on the Income tax portal.
TCS is payable on transfer of funds
Under the Liberalised Remittance Scheme, a resident Indian can transfer up to $2.5 lakh (approximately Rs 1.84 crore) abroad in a financial year. But there is a tax collected at source (TCS) if the amount exceeds Rs.7 lakh in a year at 5% of the amount exceeding Rs.7 lakh, and can be claimed as a refund when the taxpayer files his income tax return.