Allocate to US-focused funds despite shifting tax landscape: Experts

Capitalise on the geographical diversification and currency hedge they offer

As the financial year draws to a close, three prominent fund houses —Franklin Templeton, Mirae Asset, and Edelweiss Mutual Fund —recently opened up their international schemes for subscription. Investors who act swiftly and subscribe by today (March 31) will reap the benefits of indexation. However, starting April 1, capital gains from these schemes will be taxed at the investor’s slab rate. Due to these impending tax changes, many investors are questioning the wisdom of investing in international funds, particularly US-focused funds, that have traditionally been popular among Indian investors.

Experts maintain that investors should make their decision based on the merits of the asset class, rather than tax treatment alone. “Indian investors should continue to invest in international funds for the portfolio diversification benefit they can provide,” says Kaustubh Belapurka, director, manager research, Morningstar Investment Adviser.

Some investors have halted their Systematic Investment Plans (SIPs) and opted for lump sum investments to take advantage of the tax benefit available until March 31. “Asset allocation should be the key criterion for deciding how much to invest. If you are under-allocated to US equities, now is a good time to add to your exposure,” says Belapurkar. While tactical overexposure to a small extent is acceptable, excessive allocation to benefit from favourable tax treatment should be avoided, given the near-term risks the US market faces.

Do away with home bias

Most Indian investors’ portfolios have a strong home bias and hence would benefit from the geographical diversification US-focused funds can provide. In the past, there have been several years when the Indian market underperformed and the US market outperformed (and vice-versa too). “Sometimes money flows to emerging markets and sometimes to developed markets. Exposure to the US market can improve Indian investors’ risk-adjusted returns,” says Gautam Kalia, senior vice president and head, super investors, Sharekhan by BNP Paribas.

Valuations have turned attractive. “The past 18 months’ correction has brought valuations in line with long-term averages,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

US-focused funds can also provide Indian investors with exposure to many industries, like semiconductors, that are not available in the Indian markets. Many of the world’s most innovative technology companies are listed in the US.

Investors with dollar-denominated goals would gain from investing in them. “US-focused funds can provide protection against currency risk for goals such as a child’s higher education or a world tour,” says Kalia.

Near-term risks

The US market faces a few issues in the near term. “There could be earnings downgrades and the Federal Reserve could hike rates more aggressively than the market expects,” says Dhawan. Recession remains a possibility and more banks could fail. Experts, however, say such issues should not deter long-term investors.  

Another risk is of a behavioural nature. “Investors often enter these funds when past returns have been strong,” says Belapurkar. After a strong run-up, the US market enters the inevitable cyclical downturn. Investors who entered them late in the cycle with the aim of earning quick returns often get disillusioned and exit at a loss.

Stay diversified

Have diversified funds as core holding even in the international portion of your portfolio. Those who have a view and a strong understanding of specific sectors may take limited exposure to thematic strategies, but beware their high volatility.

Investors with equity-heavy portfolios (where equities constitute 60-70 per cent of the overall allocation) should opt for US-focused funds. Those with debt-heavy portfolios may do without them.

Take a 20 per cent exposure to US-focused funds (of total equity exposure) and maintain it by investing systematically. Enter with a horizon of at least 7-10 years.