Offshore Investments as a means of Diversification
The first rule of any good investment plan is diversification. To spread your investments across financial products, asset classes, and even within each asset class, is to manage risk efficiently.
Risk is inherent to any investment and exists at any given point during the investment period. Risk comes from uncertainty which creates volatility in the markets, yet at the same time creates little windows of opportunities that could lead to better returns and higher wealth-creation potential. So, in a way, risk is necessary as well.
But risk is only beneficial when we learn to manage it and minimise its ability to adversely affect our investments. Which is where diversification comes in - the spreading of our investments across products and asset classes so that the risk of potential loss posed by one product or asset class can be cancelled by the growth opportunities of another product or asset class in the portfolio.
The simplest means of diversification is to divide investments between equity, debt, gold, real estate, etc. among others. Investors can further reduce risk through exposure to different types of mutual funds that invest across categories. There are equity funds, debt funds, hybrid funds, thematic/sectoral funds, ETFs among others, that are diversified across stocks, sectors, and assets.
What are Offshore Funds?
Another diversification opportunity is the offshore mutual fund, which as the name suggests invests offshore or outside the country. These funds are of two types – one that invests directly into stocks of a particular region and the other that invests in funds that invests in such stocks. When a mutual fund takes exposure in other funds by way of investment, it is called a Feeder Fund or Fund of Funds (FoF).
Offshore investing as an opportunity could be justified after investors have had adequate exposure to funds in their own geography. In India, there are several offshore funds which have investments in regions ranging from Asia, Europe to the USA. The aim behind an offshore investment is to enhance the return potential of a portfolio by capitalizing on the growth opportunities present in another region.
Investors looking for exposure to foreign equities would do much better to go through offshore funds. While direct investment into foreign equities has its benefits, but the registration and documentation requirements process is much more tedious and cumbersome as there strict domestic rules regarding investments in offshore assets. Similarly, the region of choice for investment will have its own compliance rules.
Moreover, international exposure through offshore funds could provide access to successful brands and businesses that are otherwise out of reach for most small investors in a single investment. Stocks of some of the biggest names in the world of technology, financial services, healthcare, manufacturing that are specific to that region could be available to investors who would otherwise have little to no access to these names. Typically, an investor from an emerging market such as India should look at investing in more mature markets for a diametrically opposite experience. Developed and mature stock markets, such as the USA, are relatively stable and less volatile. Emerging markets, on the other hand, are still developing and could see more volatility.
Risks in Investing Offshore
Offshore funds are high-risk, high return funds as they are exposed to economic, geopolitical, and currency risk among other risks.
Just as it is with any investment, offshore funds also have economic risks which emanate from a slowdown in economic growth of that country or owing to any political turmoil that the country maybe going through. What makes those investments particularly risky then is the currency risk that comes with it. A slowing economy could have large repercussions and make currency movements volatile. While offshore investments are conducted in USD, any change in the local currency with relation to the USD could cause volatility in returns as well./
Geopolitical risks come next as economies grow increasingly interdependent on each other. The effects of any event in one part of the globe can be felt across the globe in a big or small way depending on the correlation among the economies. Among some recent examples of geopolitical risks are volatility in crude oil prices due to supply-side disruptions, the US-China trade war, and of course, the Coronavirus pandemic.
Taxation of Offshore Funds
Capital gains from offshore funds will be given a debt tax treatment. This means that investments for a period of less than three years are considered as short-term and taxed as per the individual’s tax slab. Investments held for three years or more are considered long-term and taxed at 20% with indexation benefits.
Also, these funds are generally domiciled in locations around the world that are tax-efficient, thereby allowing investors to take benefit of lower/nil tax rates as per the applicable Double Tax Avoidance Treaty (DTAA) with India. Currently, tax exemption in gains from funds where the fund manager is based in India, even if the fund itself is based outside the country is allowed, subject to fulfillment of certain specified conditions.
Disclaimer: Any comparison/data mentioned in this material is for general information only and not intended to be relied upon as investment advice and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Information and content herein have been provided by CRISIL Research, a Division of CRISIL Limited, and is to be read from an investment awareness and education perspective only. Recipient are advised to seek independent professional advice before making any investments. In view of individual nature of tax consequences, investors are suggested to consult their tax consultant before making any decision on investments. The views / content expressed herein do not constitute the opinions of SBI Mutual Fund or recommendation of any course of action to be followed by the reader. SBI Mutual Fund / SBI Funds Management Private Limited is not guaranteeing or promising or forecasting any returns. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
An Investor Education and Awareness Initiative by SBI Mutual Fund
- Investors should deal only with registered Mutual Funds, details of which can be verified on the SEBI website (https://www.sebi.gov.in) under 'Intermediaries/Market Infrastructure Institutions'.
- Please refer to website of mutual funds for process for completing one-time KYC (Know Your Customer) including process for change in address, phone number, bank details etc.
- Investors may lodge complaints on www.scores.gov.in against registered intermediaries if they are unsatisfied with their responses. SCORES facilitates you to lodge your complaint online with SEBI and subsequently view its status.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.