By Mayank Bhatnagar

International Funds and ETF’s in particular have certainly piqued the curiosity of many Indian investors of late. But before we delve into the contentious topic of whether international ETF’s warrant a place in your portfolio, we believe you should begin with the important question of why you are considering it in the first place. Is your purpose offshore diversification, wealth creation for long term goals, or something else?

In our experience, very few investors actually end up deriving long-term value from international ETF’s for a host of reasons. The first one is how ETF’s are structured in the first place. Since ETF units are bought and sold on stock exchanges like shares, most investors do not really get into them for geographical diversification – but rather, to chase short-term returns.

Since a lot of ETF’s are thematic in nature (for instance, FANG+ or NASDAQ 100), they catch the fancy of investors only after they have gone up, such as the boom in US tech stocks during the pandemic.

This is a very dangerous phenomenon because these themes are invariably cyclical, and mean reversions are sharp and devastating for retail investors who usually cannot understand why their capital is suddenly down by 40%-50%! They then get off the roller coaster at or near the bottom of the cycle, only to miss the uptrend when the downturn reverses. This cycle continues until a lot of wealth is eroded.

Since it is difficult (though not impossible) to invest systematically in ETF’s, they are relatively unsuitable for long term financial planning or goal planning as well. In order to be successful with equity investments, dispassionate investing through the SIP route is a time-tested success formula.

With this advantage gone, the element of speculation with international ETF’s becomes all the higher, resulting in poor outcomes. A lot of investors can be found trying to ‘time’ their ETF purchases every month while waiting for a correction. This is a fruitless endeavour with very little chance of success.

International ETF’s do not carry the cost advantage that domestic ETF’s do either. In general, expense ratios for international ETFs tend to be higher than the averages because of the higher costs of investing abroad. ETF’s that replicate international indices will typically have expense ratios ranging from 0.6% to 0.7%, which is 5-7 times higher than the costs associated with investing in a typical domestic ETF where the underlying is a local index such as the NIFTY.

The tax inefficiency associated with investing into an international ETF is another dampener. In India, returns from international ETF’s attract debt taxation – that is, short term capital gains are added to your income and taxed at the margin. Long term capital gains are taxed at 20%. With indexation benefits being done away with recently, the tax inefficiency has worsened. In a nutshell, international ETF’s are several times more expensive, and also not as tax efficient as domestic ETF’s.

In general, we have observed that investors focus a lot of their efforts on “where to invest,” while giving very little thought to important things like mapping goals, setting correct expectations, understanding risk/reward, and following a disciplined investing strategy. The fascination for international ETF’s is an extension of this mindset of always trying to predict the “highest return investment” – but with one eye on the rear-view mirror!

The case for geographical diversification simply is not strong enough for a retail investor who has a portfolio of less that $500,000 (Rs. 4 Crores). It would be best to stick to local funds and focus your efforts on following correct investing practices instead.

(Author is Co-Founder & COO of FinEdge)