Options To Invest In International Equity Are Drying Up For Retail Investors

Over the past two years, the lure of greener pastures has drawn many Indians to invest in equity overseas, either through mutual fund schemes that invest in companies and exchange-traded funds abroad or directly through the Liberalised Remittance Scheme.

But these opportunities are slowly drying up, with regulators refusing to change limits placed on mutual fund investments and the government having moved to collect tax on most foreign remittances.

There are currently three major routes for Indian investors to deploy funds in international equities. First is through mutual fund schemes, which in turn have exposure to stocks listed abroad. The overall limit for the mutual fund industry through this route stands at $7 billion, and each fund house has a limit of $1 billion.

The Securities and Exchange Board of India had halted all investments in such funds after the limit was breached but then allowed fund houses to selectively open investments if room opened up because of redemptions.

The second route is through mutual funds that invest in exchange-traded funds abroad. The industry limit under this route currently stands at $1 billion, and each fund house has a limit of $300 million. Once restrictions were placed on the first route, the demand for these funds increased exponentially. Currently, there is sufficient headroom in this category for the industry, but already one fund house has announced it will stop subscriptions.

The third route, more popular among investors with greater means, was to use the large $250,000 per year limit of the Liberalised Remittance Scheme to invest in assets abroad.

Earlier this month, Kotak Mahindra Mutual Fund announced the temporary suspension of subscriptions to the Kotak NADAQ Fund of Funds. In a Feb. 9 notice, it said that all lumpsum investments would halt with effect from Feb. 10 and all existing systematic investment plan and systematic transfer plan installments would be paused from March 1.

This fund, which started on Feb. 9, 2021, saw its assets under management grow nearly seven times from the start of April 2021 to Rs 2,052.6 crore as of Jan. 31 this year. At the current exchange rate, the AUM is above the prescribed limit of $300 million per fund house.

Other fund houses with large exposure to overseas equity will likely also have to stop subscriptions, with inflows coming in thick and fast. Motilal Oswal Mutual Fund, for one, currently has lumpsum and SIP investments open in its funds that invest in equity abroad. Its two primary offerings, the Motilal Oswal Nasdaq 100 ETF and the Motilal Oswal S&P 500 Index fund account for the bulk of assets under management in this category.

The fund house operates its own exchange traded fund, so its offerings fall within the wider $7 billion limit. As of Jan. 31 this year, the Nasdaq 100 ETF had an AUM of Rs 5,224.68 crore, while the S&P 500 Index Fund had an AUM of Rs 2,449.12 crore. This puts them very close to the $1 billion limit.

"The industry has been waiting for new limits," Pratik Oswal, head of ETFs and Index Funds at Motilal Oswal Asset Management, told BQ Prime. "Right now, it is all open for subscription. We’ve been using the redemptions we’ve had over the past year to allow for fresh investments. I can’t comment on how long it’ll be open. We’ve had increasing interest over the past month."

Finance Minister Nirmala Sitharaman announced in Budget 2023 that, with the exception of expenses for education and medical purposes, all outflows from India under the LRS would be subject to a 20% tax collected at source. This kicks in on July 1.

This means that any investments routed through LRS will have a 20% tax collected at the source. The tax collected in this way would be available as a credit for the investor and could be set off against other tax liabilities during the year. However, it creates a cashflow issue for an investor, according to Shalini Sekhri, chief executive officer at Scient Capital.

"Those with the means are already using this window to send funds abroad," she said.

Investments in international equity are a great way to diversify a portfolio, according to Prableen Bajpai, founder of FinFix Research.

"As such, in the event of a stoppage in subscriptions to a particular scheme, we’re telling investors not to reallocate to other international funds. Rather, they should shift the allocation to other schemes in their portfolio and wait for clarity on the limits," said Bajpai.

She added that fund houses should prioritise investments through SIPs. "Ideally, mutual funds should allow retail investors to continue with SIPs where possible. To do this, they would have to plan their limits better," she said.