International Investing for Indians: The Direct Way

In the previous post, we discussed various options offered by Indian mutual fund companies for international diversification. Though convenient, they may not be the best option for everyone.

For instance, if you are handling a large sum, say ₹30+ lakhs, the performance drag, because of the high tracking difference¹, may seem too large in absolute terms. Or you may be seeking diversification opportunities beyond those offered by the Indian fund companies. In such cases, investing abroad directly may be a better alternative.

At a high level, this is how direct investing works:

1. Create a foreign brokerage account (for instance, with Interactive Brokers)
2. Fund the brokerage account in a foreign currency like USD or EUR, by remitting INR abroad
3. Use the money to buy foreign-listed ETFs or individual stocks of choice

Now, let us dig deeper into some of its distinct advantages:

Negligible Tracking Difference

For passive investors, the larger the sum invested and the longer the time horizon, the more important the tracking difference becomes. Direct investing enables you to invest in well-managed ETFs, such as SPY or QQQ, whose 5-year annualized tracking difference is just ~0.2%.

Being some of the most traded securities in the world, these ETFs also have negligible bid-ask spreads (<0.01%), making transaction costs associated with buying/selling a non-issue.

Note that being foreign investors, Indians cannot invest through local mutual funds of other countries but only through ETFs.

Access to Vast Investment Universe

No matter what geography, asset class, or investment strategy you are looking for, you will find a fitting ETF. For instance, there are active as well as passive ETFs covering developed markets, emerging markets, value investing, growth investing, trend-following, and so on. I love capital-efficient ETFs like $NTSX and $RSST which are a recent innovation. You will also be able to invest in individual stocks of companies listed abroad.

Further, the $7 Bn industry-wide limit imposed by RBI on mutual fund companies doesn’t apply to individual investors. Only restriction is the $250K (~₹2Cr) annual limit under the Liberalised Remittance Scheme (LRS).

Downsides

But direct investing also suffers from some drawbacks that you should be aware of:

• Forex Transaction Costs
• Added Complexity

Forex Transaction Costs

Investing abroad requires transacting in a foreign currency like USD or EUR. So, one needs to send money outside India, which incurs forex transaction costs. These charges have fixed plus hidden, variable components. The latter arises because the banks use a worse exchange rate than the ongoing mid-market.

Choosing a bank offering excellent forex rates, such as Indian Overseas Bank (IOB), can help minimise the overall costs. But for small amounts, the fixed fees can be a significant percentage. Carrying out fewer but larger transactions (say ₹5+ lakhs) averages out the fixed costs, reducing their impact.

Note that the forex costs are one-time while tracking difference is recurring. Even if you lose 2% of the amount upfront to forex charges, you will recoup them in a year or so as higher returns, vis-a-vis investing via Indian ETFs or Funds of Funds (FoFs) .

Added Complexity

Manual Process

RBI mandates that every time you want to send money abroad, you approach a bank and submit the relevant forms for LRS. The process may involve physical paperwork or may be digital, depending on the bank, but is manual and can’t be automated yet. This also prevents setting up monthly SIPs.

Tax Filing

Directly holding foreign assets makes annual tax filing a bit more involved. One needs to disclose the foreign assets and brokerage account details under ITR Schedule FA and pay taxes on the capital gains and dividend income (if applicable) as per the applicable forex rates. Dividend income may also require claiming a tax refund under the Double Tax Avoidance Agreement (DTAA). A good CA, however, can help you sail through the process.

Tax Collected at Source (TCS)

Since Oct ’23, one needs to pay 20% TCS on incremental foreign remittances above ₹7 lakhs in a fiscal year. For instance, if you remit ₹8 Lakhs, ₹20K would be deducted as TCS.

Since you can claim the TCS as a refund at the time of tax filing, the upfront deduction is only a minor cash flow hiccup. More importantly, if you are investing abroad, in all likelihood, you will also have domestic capital gains requiring advance tax payments. Since the TCS paid can be adjusted against the payable advance tax the issue is mostly moot.

Inheritance or Estate Tax

When assets are transferred from one generation to the next, some countries levy a tax called the Inheritance or Estate Tax. The percentage of tax varies from one country to another. For instance, the USA levies a 40% estate tax for “US domiciled” assets of more than 60,000 USD (~₹50 lakhs) in value, even for foreign investors. Ireland, on the other hand, has no estate tax for foreign investors.

A potential solution in the case of USA, therefore, is to invest through UCITS-certified ETFs, which are mostly domiciled in Ireland. Estate tax rules can be convoluted so I strongly suggest doing your research before investing.

In a future post, we will discuss the different options available for investing directly.