Investing abroad through the mutual fund route is a very convenient way of taking exposure to global assets without having to go through a lot of procedures and compliances for small investors.
This route has become popular over the years but the Reserve Bank of India has been putting restrictions on how much funds can invest abroad leading to a restriction for investors.
Now from April 1, 2024, mutual fund houses cannot accept further subscriptions into foreign Exchange Traded Funds (ETFs) too. This will require a recalibration of the strategy from investors.
Actual Situation
There is a limit that is present for the mutual fund industry as well as individual mutual fund houses for the amount that they can invest in foreign assets.
The industry wide limit is $7 billion for investments in overseas stocks and $1 billion for investment in foreign ETFs. The limit for investment in overseas stocks was hit some time ago and this led to a halt in further investments into this area.
Later fund houses were given permission to accept additional inflows only to the extent of redemptions from the existing investments. This left the ETF route open for investments for those who wanted a foreign exposure but with the industry now coming close to the overall limit here there is a curb on the investments.
Nature Of Funds
Investors need to understand this situation carefully because an ETF is different from a normal mutual fund scheme in one major respect.
When an investor goes to transact in a normal open ended mutual fund scheme they are dealing with the mutual fund at the other end who will create additional units and then deploy the necessary funds. This makes its vital for the mutual funds to stop inflows into such schemes immediately when the limit for investment is breached so that they remain within the requirements.
In case a fund invests both locally and abroad then they can take new inflows but not deploy this overseas to conform to the rules. On the other hand the ETF involve trading between investors on the stock exchange and there are market makers too who create new units. While the restriction will come on creating new units the trading between existing investors can continue which will provide a relief to the investors to some extent.
Restrictions
The restrictions that are imposed on the various fund houses from April 1, 2024, will impact them from launching new funds in this space.
When a new fund is launched and subscription collected then new units are issued and the amount is deployed in the areas where the fund has the mandate to invest. There will not be any restrictions on investors to buy into existing ETF that are listed on the stock exchanges. However, there might be an impact in terms of liquidity in the fund that you want to invest in as market makers who are appointed for the ETF will not be able to create new underlying units. This can impact the volumes in several ETFs as new supply of units will cease post April 1 and only existing units can be traded between investors.
Foreign Exposure
Slowly as one route after the other are shut, those wanting a foreign exposure in their portfolio would have to look at the Liberalised Remittance Scheme, or LRS, route to meet their needs.
There are some factors that will impact such decisions. One is that using this route for small amounts of investment might not be feasible in terms of cost of transacting and management. In addition there is also a 20% tax collection at source that one would have to contend with when using this route.
Arnav Pandya is the founder of Moneyeduschool.
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