Should you start a SIP in international funds or ETFs?

Investing in mutual funds can be confusing at times, especially for new investors. The range of products offered by Asset Management Companies is vast, let alone the subcategories under each mutual fund category. For example, for saving tax every fiscal year, investors consider Equity Linked Savings Scheme (ELSS), an open ended equity scheme that comes with a predetermined lock-in period of three years. Investors who wish to benefit from both equity and debt asset classes consider hybrid funds or balanced funds. Similarly, investors who want to gain exposure to stocks across mid, small and large cap markets consider investing in flexi cap funds.

Every mutual fund scheme has unique attributes which investors can consider adding to their portfolio based on their risk appetite, investment objective, and investment horizon. These days, there is a lot of buzz surrounding international funds as well as exchange traded funds that have led investors confused on where to invest their hard earned money. International mutual funds offer investment opportunities through a feeder fund whereas exchange traded funds offer passive management and high liquidity. To determine which scheme is ideal for you, you may have to understand the differences between these two mutual fund schemes.

What is an International Fund?

It is now possible to invest in a diversified portfolio of international stocks through international mutual funds. Investors who wish to gain exposure to some renowned global giants like Apple, Facebook, Google, Microsoft, Netflix, etc. may consider investing in international funds. Such investors wish to be a part of the growth stories of such companies, some of whose products and services they’re already using. Also referred to as overseas funds, international mutual funds invest a majority of their investible corpus in equity and equity related instruments of companies that are publicly listed outside India. These funds give investors a chance to create wealth by investing in foreign companies, thus offering diversification beyond geographical boundaries.  

Reasons to consider international funds

They offer true global diversification: Mutual fund experts recommend investors always have a well-diversified portfolio. A well diversified portfolio alleviates the overall investment risk. To add to that, it gives investors an opportunity to explore foreign markets and gain exposure to stocks of companies listed outside India. To avoid concentration risk one can consider investing in an international mutual fund that has a well-diversified portfolio. Overseas funds give an international touch to an individual’s domestic investment portfolio.

Treated as debt funds for taxation purposes: International mutual funds only invest in equity and equity related instruments of companies that are listed in foreign countries. They do not invest in equity and equity related instruments of companies listed in the country of the fund’s origin. Hence, for taxation purposes, international mutual funds are treated the same way as debt mutual funds in India. 

They do not have any lock-in period: International mutual funds do not come with a statutory lock-in period like some solution oriented schemes like retirement savings funds that come with a minimum lock-in of five years or till the investor attains the age of retirement. International funds do not have any predetermined lock-in period which allows the investor to enter or exit these funds at any given time. 

There are different types of international funds to choose from: There are four types of international funds in which one can consider investing in. For example, investors who wish to invest in a specific region like the United Kingdom, Europe, or South East Asia, such investors can consider region specific international funds. Some investors who only seek exposure to equity markets of a specific country like the US, Japan, etc. such investors can consider investing in country specific funds. Investors confuse international funds with global funds as they sound similar. An international fund does not invest in the domestic markets, but a global fund invests in foreign markets as well as in the domestic markets from where it originates.

What is an exchange traded fund?

 Exchange traded funds or ETFs are passive mutual funds that invest in their benchmark for generating capital appreciation. They have a passive investment strategy where the ETF mimics the performance of its underlying index with minimum tracking error. What distinguishes an exchange traded fund from other mutual funds is that its units are available for trading at their current market price during live trading hours. 

Why do certain investors consider investing in exchange traded funds?

ETFs have a low expense ratio: Exchange traded funds are passive funds. The fund tries to replicate the performance of its underlying benchmark. ETF fund managers do not actively manage the fund as it is designed to generate capital appreciation by mimicking the returns generated by the underlying securities. Hence, ETFs are known to have a low expense ratio which can help an investor in generating better returns in the long run. 

Void of human error: There are certain mutual fund investors who want their investments to remain free of human involvement. Investing in passive funds like exchange traded funds there is the active participation of the fund manager. This is one of the reasons why some investors consider ETFs as they try to generate returns while keeping tracking errors to a minimum.

High liquidity: Investors who want to buy or sell their mutual fund units can do so by placing an order request to the AMC. These transactions take place based on the scheme’s NAV (Net Asset Value) that is determined at the end of the day. However, this doesn’t apply to exchange traded funds. ETFs are publicly listed at the stock exchange and one can trade them just like they trade in company stocks. This makes ETFs a scheme with high liquidity as anyone can enter or exit them at their current market price. 

There is a variety of ETFs to choose from: There are different types of ETFs that investors may consider depending on investment objective and risk appetite. Investors seeking exposure to international markets can consider international ETFs. Investors who wish to invest in gold as an asset class without dealing with the hassles of owning physical gold consider gold exchange traded funds. ETFs that invest in an index like SENSEX 30 or NIFTY 50 can consider investing in index ETFs.

What is a Systematic Investment Plan? Why should you invest in mutual funds like ETFs and international funds via SIP?

Mutual fund investors can make a lumpsum investment or they can start a monthly SIP in any mutual fund scheme of their choice. Investors may be able to buy more units by making a lumpsum investment, but they will also expose their entire investment sum to market volatility right from the beginning of the investment cycle. With Systematic Investment Plan, they can invest small fixed sums regularly and build a commendable corpus in the long run. Investors with a long term investment horizon who wish to target certain long term financial goals can consider investing in mutual funds via SIP. Investors who plan for building a retirement corpus or are planning to secure their child’s future financially can gradually do so via SIP. 

Systematic Investment Plan or SIP is a type of investment tool where you can invest a fixed amount at regular intervals in a mutual scheme. Investors can decide on an investment sum that they are comfortable investing and invest this sum regularly till their investment objective is accomplished. Since there isn’t any higher limit on SIPs, investors can invest a sum that is ideal for their risk appetite and financial goal. However, an individual cannot invest a sum lower than what is mentioned in the Scheme Information Document (SID).

SIPs also allow investors to take advantage of market volatility. Several investors avoid investing in equity oriented mutual funds because they fear that their investments will incur losses during volatile markets. However, if they invest via SIP, their investments might be able to leverage the market’s volatile nature. When the NAV is low, a SIP lets the investor buy more mutual fund units. Similarly, when the markets are performing and the NAV is high, investors buy fewer units. Since equity markets fluctuate from time to time, investors may be able to buy more units in the long run. This way, the average cost of purchase reduces. This investment technique is referred to as rupee cost averaging that averages out the overall cost of purchase. SIP investors may be able to buy more units if they continue their SIP investments even when the markets are volatile. 

A retail investor can stop his/her SIP investments at any given time. There are no cancellation charges involved. Investors can even modify their monthly SIP sum as per their convenience. Now it is easier for SIP investors to calculate their future returns. With the introduction of an online SIP calculator, calculating future SIP returns has become simpler as this tool computes data and produces results in a jiffy. 

Another benefit that SIP investments offer is the power of compounding. In mutual fund terms, the word compounding refers to the interest earned from the interest that is reinvested after the initial investment amount generates returns. Over time, this compounding effect might be able to convert the investor’s small investment SIP sum into a commendable corpus. However, to benefit from compounding, investors must not stop their SIP investments midway and ensure that they have a long term investment horizon.