What are offshore funds?

When investing overseas, investors should generally select well-known funds that have reputations for being fiscally strong and legal in their dealings

June 20, 2012 4:35 IST | India Infoline News Service
An offshore fund refers to a mutual fund that invests its assets abroad and not in India. Offshore funds offer investors access to international markets and major exchanges. They are similar to traditional mutual funds.

According to Vidhata Bhide, research analyst, PersonalFN, offshore funds are typically structured to take economic advantage present in respective foreign nation(s). In India, any fund that invests at least 65% of the assets in domestic equities would be treated as a domestic equity oriented fund and not an offshore fund though it has exposure to foreign markets.

Some of the offshore funds
Franklin US Opportunities Fund, Reliance US Dollar Fund, DSP BlackRock US Flexible Equity Fund, DWS Gold and Precious Metal Offshore fund, HSBC Brazil Equity Fund and ICICI Prudential US Bluechip Equity Fund.

Sankaran Naren, chief investment officer-equity, ICICI Prudential Asset Management Company, says, “Offshore funds provide country and sector diversification. Investors investing in offshore funds would get direct access to the global brands, which benefit from a global business and consumption. However, one has to have a long-term horizon for investing in offshore funds to beat inflation.”

 “Every country has strengths and weaknesses in terms of industrial leadership. For example, Korea has leadership in electronic goods. India has a leadership in services industries such as IT and offshoring services. Russia and Brazil are mineral rich nations hence the mining sector is strong. Germany has a leadership in automation and engineering,” says Bhide.

He adds, “An Indian investor investing only in Indian equities would have limited options while investing in energy sector. But if he has been given a chance to invest globally, he may invest in Lukoil (Russia) which alone contributes to 2.2% of global oil production. Quality is a global phenomenon and shouldn’t be constrained by limited universe of stocks.”

While several potential benefits to investing overseas exist, tax breaks are frequently one of the most important advantages for investors. Offshore mutual funds are usually established in countries that provide significant tax benefits to foreign investors. As a result, these investors are often able to reduce the amount of taxes they pay. Some popular countries for offshore investments include the Isle of Man, the Bahamas, Bermuda and the Cayman Islands.

Another advantage associated with offshore mutual funds is that they are often set up in countries with less investment regulations which bring down the cost in managing the fund.

There are some risks involved while investing in offshore funds such as price and volume volatility in the capital markets, interest rates, currency exchange rates, changes in government policies, taxation laws and other political and economic developments.

 “On the whole, the currency risk is the biggest risk. Unfavorable movement of currency has the potential to erase gains earned overseas. It is important to note that some offshore funds are thematic and some are country-specific and others are both—asset-specific and country-specific. They involve the highest risk. For example, there may be a fund investing in global mining stock. There may be a fund focused on equities in Brazil. Finally, the other variation could be a fund investing only in Brazilian mining companies,” says Bhide.

Tax benefits
Himanshu Pandya, vice president & head-product development & delivery, ICICI Prudential AMC, said, “Offshore funds—which have an exposure to foreign assets—would be classified as debt mutual funds for the purpose of taxation in India. Hence, the fund will bear a tax which is similar to fixed income fund. The dividend option in the fund will attract dividend distribution tax.”

He adds, “If the fund is redeemed within one year, then it will attract short term capital gains which will be added to the income. If the fund is redeemed after one year, it will attract long term capital gain of 10% without indexation and 20% with indexation.”

Bhide elaborates, “While investing in offshore funds, it is vital that you have some basic understanding of both economic and political situations of the country in which fund house is investing your money. You may want to de-risk your domestic mutual fund portfolio by taking advantage of the economic synergy in foreign countries (which intend to offer high growth and other fundamental strengths), but you need to ensure that you are allocating only a very small portion initially.” While investing in offshore funds, you need to prefer those funds which take broader exposure to international opportunities or emerging markets as a whole, rather than acute country-specific exposure.

Pandya points out, “Investors should also take into consideration that one fund from an emerging market should not invest in another emerging market. They need to make sure that a fund from emerging market is investing in a developed market.”

Investors should educate themselves before investing in an offshore fund. When investing overseas, investors should generally select well-known funds that have a reputation for being fiscally strong and fully compliant in their dealings. While foreign countries with lenient tax and investment laws may present some advantages, investors should do their homework before parting with any capital.

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