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Why NRIs/PIOs should Invest Directly in Indian Mutual Funds

Introduction

  • Direct investment in Indian mutual funds is preferred over investment in India dedicated Exchange Traded Funds (ETFs) available in the US because of diversification benefits. India dedicated ETFs generally have concentrated portfolios with limited investment options (US ADRs)
  • Past performance of Indian mutual funds has been better than that of India dedicated ETFs
  • Investing in Indian mutual funds is tax efficient because of tax free dividend income and zero long term capital gain tax

Limitations in India Dedicated ETFs

Diversification

  • India dedicated ETFs invest primarily in ADRs or GDRs, of Indian companies. Since the number of Indian companies with these GDR and ADR offerings are limited, ADR (12 Indian companies) and GDR (< 70 Indian companies), the investment opportunities for India dedicated ETFs are limited

  • Therefore, the portfolio lacks diversification and tends to be concentrated with a limited basket of stocks

Dividend Reinvestment Option

  • Indian mutual funds generally provide an option for dividend to be reinvested in the fund without charging any entry load unlike India dedicated ETFs where dividends declared are not allowed to be reinvested directly

Units Allotted

  • Investors can hold units up to four decimal places (i.e. fraction of shares) in case of Indian mutual funds unlike India dedicated ETFs where these are sold in whole shares.


Performance of India Dedicated ETFs Compared with Indian Mutual Funds

  • Indian diversified equity mutual funds have performed much better than the India dedicated ETFs in the U.S.
  • Certain Indian mutual funds have not only out performed India dedicated ETFs but also the BSE Sensex

Fund Name

1st Jan 2004 (Rs)

31st Jan 2008 (Rs)

Absolute % Gain

Compounded Annualized Growth Rate %

Morgan Stanley India Investment Fund (ETF)

10000

14593

45.93%

9.71%

Blackstone India Fund (ETF)

10000

17681

76.81%

14.99%

Franklin India Blue Chip Fund

10000

26560

165.6%

27.05%

HDFC Growth Fund

10000

28139

181.4%

28.86%

Kotak 30

10000

41728

317.3%

41.93%

SBI Magnum Equity

10000

29666

196.66%

30.43%

BSE Sensex

10000

29285

192.85%

30.33%

Tax Implications for Equity Oriented Indian Mutual funds: for Non Resident Indians (NRIs/PIOs)

  • The Indian taxation norms are relatively lenient with tax free dividend income and zero long term capital gains tax in case of equity oriented mutual funds
  • While investing in US based ETFs, NRIs needs to follow relatively high taxation slabs as indicated below

Category

India*

USA

Short Term Capital Gains Tax

15%**

As per income tax slabs up to 35%

Long Term Capital Gains Tax

Nil

5% - for tax payers in 10% and 15% tax brackets

15% - for tax payers in 25%, 28%, 33% and 35% tax brackets

Tax on Dividends

Nil

5% - for tax payers in 10% and 15% tax brackets

15% - for tax payers in 25%, 28%, 33% and 35% tax brackets

* While there is a double taxation treaty between the US and India there might be some tax implications in the US. Please consult your local tax consultant for the same.
* * There is an education cess of 3% on the tax amount that is levied at all income levels.

Expenses/Cost involved

India Dedicated closed ended ETFs

1% - 1.5%

Open Ended Indian Mutual Funds

2.5%

Open Ended Indian Index Funds

1% - 1.5%

Investment Options for NRIs/PIOs in the U.S.

1. India Dedicated Exchange Traded Funds (ETFs) - How they work?

  • ETFs are closed ended funds bought and sold on a stock exchange
  • The price of the fund on the stock exchange is different from the NAV of the fund and the differential is the discount or premium to the book value
  • ETFs invest at least 65% of total assets in Indian companies through American (ADR) or Global Depository Receipts (GDR)
  • In addition, they have a mandate to invest in preference shares, convertible debentures and share purchase warrants

2. Indian Mutual Funds (Introduction and Requirements)

  • NRIs/PIOs can invest in Indian mutual funds under general exemption granted by RBI

  • NRIs/PIOs can invest in all Indian mutual funds except in funds promoted by Asset Management Companies based in the U.S. (Fidelity, Franklin Templeton and HSBC)

Requirements:

  • Permanent Account Number (PAN) card and Know Your Customer (KYC) registration is mandatory

  • Opening an NRE Account in India is advisable in order to retain the option of repatriating money invested in India

  • It is advisable to appoint a local representative in India to sign and transact on one's behalf. This could save delays and the hassle and cost of sending documents through courier

iTrust Observations

NRIs/PIOs should consider investing in Indian mutual funds directly because of the following reasons:

  • Diversification - The basket of stocks available to India dedicated ETFs is limited
  • Performance - Since mid 2006, Indian mutual funds have outperformed India dedicated ETFs with a significant margin
  • Taxation - There is no tax on dividend income and long term capital gains tax is zero in India when investing in Indian equity mutual funds

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Comments
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ashfaque kazi said :
03/02/2010 		can a US National who is an Indian by origin and Now working in INDIA since 2007 invest in indian equities directly, Mutual funds and real estates. Does he have to change his visa status? Can he then apply for a pan card and do the KYC norms?
 
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