- What are offshore funds?
- Offshore Funds in India
- Scepticism Around Offshore Funds in India
- Why should you invest in offshore funds?
- Taxation of Income and Gains from Offshore Funds
- Risks of Investing in Offshore Funds
- Measures to mitigate the offshore fund investment risk
- The current state of India focussed Offshore Funds and Exchange Traded Funds (ETFs)
What are offshore funds?
Offshore funds also referred to as the international funds are different mutual fund schemes that make investments in the foreign markets.
These schemes are known to invest in equities and stocks, shares, interests, partnerships, mutual fund schemes or even fixed income securities in the international market.
An international fund is an open-ended investment fund that could have its own entity, could be a corporation, a limited partnership firm with a presence abroad or a unit trust.
These funds and the Asset Management Companies (AMCs) managing these funds, have to comply with the rules and regulations devised by the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) and also with the foreign country, where they have been registered.
The operating pillar behind an offshore fund entails a custodian, a fund manager, an administrator and a prime broker.
Offshore Funds in India
India has a huge variety of offshore funds in the form of thematic, country-specific and region-specific schemes.
You can choose from varied funds that consider the US or Brazil or the European market, as a safe haven for mutual fund investments.
There are sector-specific funds too that you can select from in sectors like energy, gold, real estate and consumption.
The process to invest in this fund is fairly simple, first, you have to shortlist the fund after having done thorough research on both the Indian and the international markets.
Either you can invest online or you can submit a cheque and the application form to the selected fund house.
All these transactions are essentially done in the home currency, i.e. the Indian Rupee. There are three factors like taxation, investor demand and regulation, that influences the country to choose the fund they want to incorporate in.
If you, as an Indian investor is planning to invest in a mutual fund from the US, you have to consider your need and demand for the fund, the financial market rules and regulations that you would have to abide by and the tax implications of this investment. If it proves to be beneficial and lucrative, you would certainly decide to go ahead with this investment.
Alternatively, these funds also known as a fund of funds can be invested in the international markets either directly or have the option to be invested in other funds in those markets.
The international funds are called the ‘Fund of funds’ because it invests in companies located anywhere in the world.
Usually, the accumulated money will be in stock markets of other countries like the USA, Brazil, etc., in this fund.
Since the same fund is invested in more than one foreign market, it implies more risk exposure, thereby indicating chances of higher returns too.
The second option is called the ‘Feeder route’ and is quite prevalent these days. Funds investing in international mutual funds scheme generally of the parent company and is managed by an overseas fund manager. This is the concept of a ‘Feeder Fund.’
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Scepticism Around Offshore Funds in India
Foreign regulatory authorities manage international investment influx into the Indian markets as the Indian regulatory bodies like the RBI and the SEBI do not encourage fund managers based in India to manage foreign mutual funds.
In due course of time, asset managers who were employed by these funds in India to handle their accounts, relocated to offshore sites, as they were not authorized to handle offshore funds from India. This disrupted the growth of these funds here.
Hence few activities had to be shifted to manage the mutual fund sector internally.
One way is to manage the offshore funds from India without levying any tax on them as an Indian entity.
Alternatively, the RBI approved direct investment by overseas investors in foreign mutual funds established in India in 2015.
Some remedies were devised to ease this situation with the implementation of Section 9A of the Income Tax Act 1961 that was amended in the 2015 Finance Bill.
It states that the revenue from some offshore funds could claim tax exemption if a fund manager based out of India is handling them, to rule out double taxation.
Also, SEBI-registered foreign portfolio investors (FPIs) comply with broad-based requisites of diversification when it comes to the investors’ participation, thereby rendering it eligible as a viable investment option.
This leads to many investors considering offshore funds as an attractive investment option.
Why should you invest in offshore funds?
If you are in a dilemma whether to invest in an offshore fund or not, you can rest assured that you have taken one of the best financial decisions ever. Why so?
Though the Indian stock market has a diversified set of stocks, there are still many stocks or businesses that are not listed with the Indian stock exchanges, namely few IT giants and some cold beverage companies.
But the option of investing in the offshore funds can make you an integral part of their business growth stories as you diversify across sectors and geographies.
You get an opportunity to make investments in world-renowned brands and businesses, thereby creating an outreach into several sectors.
The global financial market is very volatile and with the current pandemic, rapid currency fluctuations are indeed worrisome.
The falling rupee (INR) has been a concern for Indian investors throughout this financial year.
Diversified investments could be a means to hedge the capital from so much uncertainty.
If you have invested in a US-based offshore fund and the rupee value depreciates against the dollar, the amount of a rupee to be exchanged for one dollar increases.
This signals a market downturn and loss of capital as more amount of the Indian currency has to be paid for every unit of the dollar.
Hence, the currency-adjusted returns yield positive gains for Indian investors if they invest in offshore funds.
Additionally, when the Indian market witnessed a bearish trend, the global markets could yield a higher return.
You as an investor can expect attractive investment returns as the countries in which they are invested, offer tax rebates to foreign investors (tax havens).
These offshore funds registered as an international corporation enable an easy establishment and administration of funds due to easier and lower regulations, coupled with few investment rules.
This causes the fund to reinvest the accumulated gains as the income is tax-free as these are considered a debt.
While their management fees and operating costs are comparatively lower, these funds protect the investors’ capital from being subjected a to high tax burden, which they would have otherwise been subjected to if they would invest in their resident country.
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Taxation of Income and Gains from Offshore Funds
There are few tax norms that the fund has to adhere to while trading in the financial market in accordance with the guidelines and compliance procedures mentioned under the Income Tax Rules, 1962.
International mutual funds are usually treated as a non-equity scheme for taxation, whereby they are taxed like the general debt mutual funds.
This is a major factor while you decide to invest in the offshore fund as you being the investor does not need to pay any tax on dividends declared by their schemes.
Several other factors to be satisfied by the fund, referred as eligible investment fund (EIF), would imply that the fund should be from a country with which India has a tax treaty or from a specified territory with a certain minimum number of investors.
The fund with a corpus of around 100 crores should not be involved in any kind of business operations, directly or indirectly in India.
In addition to that, the Indian investment manager or the fund manager has to be registered with the Securities and Exchange Board of India regulations and should not have any illegal connections with the eligible investment fund.
Learn more about the concept of taxation in Mutual funds
Risks of Investing in Offshore Funds
Despite getting a few advantages, there are a few limitations that these funds have, which you would like to bear in mind before making any investment.
Any kind of stock investment is risky, in addition to which international funds also have the fear of associated currency risk.
Currency risk is associated with market volatility in the value of the other currency against the Indian currency.
Since this fund is based out of a foreign country, the terms and conditions of the fund may not be well explained to the domestic investor, which might lead to unprotected and unexpected loss of capital.
Even though you invest in the international market in Indian rupee, the fund house will take into account the risks associated with the international market exposure in various currencies, tax regulations, policies and other developments in both the resident and the foreign country.
Thus, if you are an investor planning to invest in the international stock exchange, you need to be wary of the associated currency risks as any currency fluctuation will directly impact its Net Asset Value (NAV).
Any bearish movement of the stock will adversely affect its returns.
Moreover, a huge investment is required to set up an offshore fund, which is also associated with higher risks both in the resident and foreign country.
Investments in these funds are usually done for the long term to earn higher returns, so the investor suffers from some liquidity risk too.
Measures to mitigate the offshore fund investment risk
Offshore fund investment is very risky and therefore, it’s essential to keep a few points in mind before you decide to invest in foreign stock.
First and foremost, you should do a deep dive research and analyse the current economic and political conditions of the offshore country in which the selected fund house has plans to invest in.
Most of these funds offer a competitive advantage, but few non-mainstream funds could be subject to fraudulent activities due to some lenient and relaxed regulations in the offshore locations.
Initial investment should be a smaller amount to start with to understand the market sentiments.
While selecting funds, you should choose funds that give better exposure to investments for global opportunities, rather than being a country or region-specific.
Since the financial market is flooded with different types of funds, you should select those funds which are financially stable and have a transparent trading mechanism.
Read more about the different types of mutual funds schemes
The current state of India focussed Offshore Funds and Exchange Traded Funds (ETFs)
Investments into India-focussed offshore funds are considered to be long term in nature vis-à-vis investments in ETFs, which are short term in nature.
India-focussed offshore funds and ETFs are some of the prominent investment vehicles through which foreign investors invest in Indian equity markets.
Research by Morningstar Direct, an investment analysis platform, states that India-focussed offshore funds and exchange-traded funds (ETFs) registered a whopping figure of $1.5 bn during April to June 2020. Despite the global pandemic, the offshore funds witnessed a bigger net outflow of $14.5 bn from February 2018 to June 2020, as compared to a lesser outflow of $4.2 bn from the offshore Exchange Traded Funds.
The higher net outflow from India-centric offshore funds indicates that foreign investors with long-term investment horizons have been adopting a cautious stance towards the country due to the current economic circumstances and the global crisis due to the pandemic.
To study the future trend of these offshore funds, you need to keep a track of how India would fare in its fight against the coronavirus pandemic versus its peer countries, and how successful is the government in restoring the country’s dwindling economy on track amidst a global crisis.
Though there’s a net outflow of $1.5 bn, an upsurge in the domestic equity market in large-cap, mid-cap and small-cap, impacted the asset base of the India-focussed offshore funds and ETFs category on a positive note by Q22020.
So, if you plan to invest in offshore funds, please ensure to evaluate the pros and cons of such an investment for better returns.