How much should you allocate to international funds?

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© Venkatasubramanian K How much should you allocate to international funds?

Most investors can benefit from having some exposure to international investments. It gives them a chance to invest in unique and compelling companies and sectors that aren’t available in the Indian stock markets.

Also, our Indian markets have a low correlation with some international markets. This low correlation, especially with developed markets, helps bring down portfolio volatility and ensures good diversification. And let’s not forget that these act as a hedge against Rupee depreciation.

But do understand that when you invest in international funds, it’s more about diversification and less about return maximization.

I think you should consider international funds only after you have a well-diversified domestic (Indian) portfolio of mutual funds.

How much to allocate to international funds?

For very small portfolios, it is better to keep the number of funds limited and remain focused on Indian mutual funds. But once your domestic MF portfolio is well-diversified, consider having some exposure to international funds.

In your overall mutual funds portfolio, you can allocate 10-15 percent to international equity funds to have a reasonable level of geographical diversification. If you don’t have any international exposure, then aiming for 10 percent is a good starting point. Also, no need to reach this on day one. Instead, you can gradually build up your position. For a small number of investors, having 15-25 percent exposure to international funds can also be considered in certain situations.

Which international funds to Pick?

Nowadays, there are several options to choose from. But that doesn’t mean you fill your MF portfolio with several international funds. Remember, these funds act as portfolio diversifiers and are not the core of the portfolio in general

Each global fund has a different risk-reward level associated with it based on the country/sector it focuses on. I think that most investors only need 1-2 international funds. And as a first choice, I suggest investing in funds focused on developed countries that have a low correlation to emerging markets like India.

Having a US-based international fund is good enough for most people as the US is a good representative of the developed markets. Within the US, one can go for S&P500-based funds or if willing to take a bit more risk, then Nasdaq-based funds.

Anything else?

Most people don’t need, it but if one is really interested in exposure to more markets and know what they are getting into,  investing in funds focused on other markets such as Europe, Japan, Brazil, China, or other nations in Asia-Pacific region may help.

If you were to ask me for allocation, I would suggest having 70-100 percent allocation to developed markets like the US and 0-30 percent to emerging markets.

Now a days, there is a race amongst the Indian AMCs to launch exotic, sectoral international funds. These funds invest in companies of one particular sector or theme in international markets. Do you need these? I don’t think so. At least not till you have a simple diversified international fund and unless you are hell-bent on taking an international sectoral bet. By the way, in my view, most people don’t need to invest in sector funds in India, leave alone international ones.

Active or passive international funds?

If you are investing in international funds focused on developed markets such as the US, I think it’s better to take the passive index fund/ETF route. Due to the maturity of developed markets, it is found that active managers are unable to beat indices like S&P500 and Nasdaq consistently.

So why take that risk at all?

Hence, for international equity investments in developed markets, invest through passive index funds. And if you really do decide to invest in developing and emerging markets, then you can opt for either active or passive funds based on availability.

As of now, there are 50+ international funds/ETFs available for Indian investors with AUM in excess of Rs 40,000 crores. And these funds focus on different geographies, markets and sectors. AMCs continue to launch new funds in this space regularly. But you don’t need to invest in all the international funds of different countries/geographies. You just need 1-2 funds maximum.

Note: Even though these funds invest in international stocks, they are treated as debt funds for taxation purpose. Long term capital gains (holding period more than 36 months) are taxed at 20 percent after indexation, while short term capital gains are taxed at the slab rate of the investor.

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