SEBI has recently issued a circular raising the limit for mutual funds to invest in foreign stocks. The amendment raises the limit on investing in foreign stocks for the entire mutual fund industry. However, the question here is whether it was necessary to do so?
The last few years have seen an increase in interest of Indians in investing in foreign securities. Therefore, it is important to think about the risks involved. Both the Reserve Bank and the Securities and Exchange Board of India (SEBI) had earlier directed to increase the limit if required.
To invest in foreign stocks or not?
Many people are worried about investing in foreign stocks. That is understandable. Whatever the investment, there is a certain amount of risk involved. However, there are several major benefits to investing in a foreign stock market
No return can be expected without taking more risk in the investment world. In the same way, diversification is necessary to reduce the risk. Investing in foreign stocks diversifies the portfolio. Many Indian investors diversify locally by investing in various companies and industries, but lack diversification in terms of both country and currency. This means that there is no investment outside of India and in currencies other than Indian currency. If risk arises in India for any reason, the Indian stock market may decline. At that time, investments in foreign stocks are not adversely affected. Thus, the equivalent of foreign investment in an investor’s portfolio remains safe. Similarly, when the Indian rupee depreciates, the exposure to other currencies reduces the risk against the entire portfolio.
2) Investment opportunities are not yet available in certain sectors in India
The Indian stock market is far ahead in terms of diversification, yet there is no opportunity to invest in companies operating in certain sectors. These areas include chip makers, social media platforms, artificial intelligence, etc. Moreover, even our largest companies are much smaller than the global giants. One should know in advance about the benefits of investing in foreign securities as well as the risks associated with it. One of these risks is country risk. It also involves political risk. The 1970s saw many instances of political instability. Because of this, investors in many countries of the world had to bear the risk. In one or two cases, countries imposed restrictions on foreign portfolio investors. This risk was imposed because investors in good times were not allowed to withdraw in case of political risks. However, this has not happened in the last two decades.
The second risk is currency risk.
We’ve talked about this risk above. However, there is another side to it. If the value of the currency in which the investor has invested decreases, the return on it decreases. The portfolio needs to be diversified to invest in different countries and different currencies to avoid national and currency risk. One of the major risks is lack of understanding of global markets. It is natural for investors not to know about world class companies. Mutual funds are useful in such situations, as they have experts in the field.
How to invest abroad?
There are two main ways to invest in foreign securities:
1) using a liberalized remittance scheme and
2) By investing in mutual fund schemes rather than investing in foreign markets.
The liberalized remittance scheme is to be used by the investor himself. That’s the decent thing to do, and it should end there. The knowledge of a fund manager can be leveraged by investing through mutual funds. All you have to do is choose a foreign investment mutual fund scheme. There are always some limitations to investing yourself. Many risks can be reduced by investing through mutual funds.