US stocks like Apple, Facebook, Alphabet, Amazon have shown a steep upward growth.
By Nehal Joshipura
US stocks like Apple, Facebook, Alphabet, Amazon have shown a steep upward growth. You may feel like buying Amazon stock instead of buying on Amazon! If you are wondering how to take exposure into foreign equity, it’s not very complicated. As a resident Indian, you can invest abroad an amount up to $250,000 per year. This is possible without explicit permission of RBI under the Liberalised Remittance Scheme (LRS). There is no cap on your investments in international funds from India.
Geographical diversification helps to get exposure to other markets. It also reduces the country risk. Negative events like war, drought, political turmoil, etc., bring country risk to the portfolio. Asset allocation is at the heart of investment planning process. Combining assets having low correlation reduces risk without reducing returns. And at the same time, it improves risk-reward trade-off for the investor. An investor should diversify across industries, asset classes and markets.
International equity portfolio
Let us understand various ways to create international equity portfolio. Let us discuss how to buy stocks abroad, the tax aspects and complexity of compliances. There are four routes of taking exposure into equity abroad for resident Indians. First one is to buy the mutual fund that invests in stocks listed on exchanges outside India.
Second is to buy such ETF or Exchange Traded Funds using a trading account. ETFs are quite similar to mutual funds. There are two differences. They are listed and traded on an exchange just like stocks. And they have lower expense ratios because they generally follow the passive investment strategy of replicating an index.
The third way is to buy ETFs investing in stocks of a foreign index and listed on a foreign exchange. This requires using a separate trading account with an international broking firm. The fourth way is to buy direct equity from foreign exchange using the same trading account. You would also need to intimate the RBI. But, this process is quite simple.
Regulatory compliance is in increasing order for these four routes. And let us focus upon tax treatment to understand the relative advantage or disadvantage for each of the routes. Global ETFs are treated like debt funds where long-term means over three years holding. Short-term capital gains tax (STCG) is as per the slab and LTCG tax is 20% with indexation. Considering positive inflation, LTCG tax of 20% with indexation may not be very different from 10% without indexation applicable on domestic equity investment. Hence, one can add them for geographical diversification if the available products meet the goals.
The third and fourth route involve opening of a brokerage account that allows you to buy from foreign exchanges at reasonable trading expenses. The applicable tax rate will be 20% on LTCG without indexation beyond one year holding period. Investing using your account can be done in active or passive way.
If you want an exposure into the entire basket of stocks, you should buy index-ETFs listed there. This gives you vast variety compared to only a couple of domestic ETFs investing in foreign equity. But, if you want to cherry-pick the stocks, you may buy direct equity. If you are buying direct equity from foreign exchange, you also receive dividends. Now, this income will be treated as income from other sources. It will be taxed at the highest slab rate.
So, you may choose to buy direct equity or diversified ETF in your trading account with a global brokerage account. Here you get the full controls. Alternatively, you may choose to go passive with ETF or fund to let them buy on your behalf from India. This is like a pedestrian ride.
Nehal Joshipura is faculty member in the finance department at DSIMS, Mumbai