Access to trading in foreign capital markets like the New York Stock Exchange (NYSE), Nikkei, or the London Stock Exchange (LSE) used to be the stuff of dreams for the average Indian investors. Watching the price of Facebook or Alphabet (parent company of Google) surge, quarter-over-quarter has left many investors’ hearts pumping in awe.
Let us begin by asking a basic question. With over 5,000 listed companies on the Indian stock markets, why would anyone want to invest in stocks abroad? The answer lies in the following factors: the huge increase in disposable income, overcoming the fear of the unknown, and the changing mindset of the savvy new-age Indian investor.
The globalization of the world economy, easing of norms in capital markets worldwide, increased access to foreign markets and forex, and availability of instant information through the internet has allowed Indians to invest in international stocks.
According to Reserve Bank of India (RBI) guidelines, “direct investment outside India means investments, by way of contribution to the capital or subscription to the Memorandum of a foreign entity or by way of purchase of existing shares of a foreign entity either by market purchase or private placement or through a stock exchange.” The RBI mandate allows Indians to remit up to US$ 250,000 per annum in foreign stocks.
Why Invest in International Stocks?
The primary reasons to invest in foreign stocks can be listed as below:
- Creation of a Nest Egg: If you are planning to settle down abroad or if your child wishes to pursue their higher education abroad, it makes sense to prepare a nest egg in your county of choice. Countries like the US, UK, Canada, Australia, or Germany are very mature markets and earn interest in highly stable currencies.
- Diversification: By opening your portfolio to global markets, you can improve the long-term returns on your investments. Market and geographical diversification will reduce overall risk exposure.
- Seizing the Next Big Opportunity: You can be ready to invest in the next Google or other tech Unicorn start-up or opportunities, which are not currently available in India. To put some context, the SBI Card IPO on the Bombay Stock Exchange (BSE) raised approximately $1.39 Billion as compared to the Alibaba IPO on the NYSE, which raised a whopping $21.8 billion in 2014.
- Investing in Your Dream Companies: Significant exposure to multinational companies in India has been inculcated both due to the availability of jobs in MNCs, as well as the consumption of their products and services. Aspirational Indian investors are happy to invest in these companies in their country of origin and chase their dreams.
The types of foreign investment vehicles that a retail investor can use are:
- Global Depository Receipts (GDR)
- American Depository Receipts (ADR)
- Foreign Direct Investments
- Global Mutual Funds
- Exchange-Traded Funds
It has now become quite simple to trade in overseas stocks. Indian investors can choose from the following options.
- Opening a Trading Account With an Indian Broker: These Indian brokers have a tie-up with foreign brokerage firms and offer you full-service brokerage to invest in foreign stocks. Examples of these are HDFC Securities, Axis Securities, and ICICI Direct. One could also go for mutual funds or ETFs, which directly invest in foreign equities. This will enable you to avoid some of the pitfalls of directly trading in unknown markets. However, high commission and fees can severely dent the anticipated profits.
- Directly Open a Trading Account With a Foreign Broker: Several foreign brokers allow Indian citizens to open an account with them to trade directly in foreign stocks, options, mutual funds, ETFs and ADRs from their home country. This option is not recommended for the casual investor, as it can be cumbersome, costly, and complicated.
- Investing Through Financial Apps: Trading apps such as Alpaca allow you to directly open an account and start trading in foreign stocks and ETFs. These trading apps provide advantages for smaller investors like Algo trading, comprehensive research, fractional share investing, zero commission charges, and no minimum balance. These platforms also educate you on different types of trading mechanisms, how to short stocks, day trading transactions, and swing trading, among others.
As with everything good, trading in overseas stocks also comes with its inherent risks. The major factors an investor should consider are:
- Exchange Rate Fluctuation or Currency Risks: As all transactions are carried out in the country’s currency or US Dollar, fluctuations in the exchange rate need to be taken into consideration. When you change the foreign currency back into Indian Rupees, the difference in the exchange rate could make your returns nosedive.
- Geopolitical Risk: Not every foreign stock market is well regulated, with insurance and protection mechanisms in place. Developed economies offer the safest trading environments, as compared to emerging ones. A country prone to economic upheaval or a weak government makes for a less stable investment environment.
- Liquidity Risk: It is important to ensure that the international market you are trading in offers high liquidity, especially at your time of need. As foreign markets could be in different business cycles or stages of development, lower capitalization could make liquifying your assets difficult.
- The Jurisdiction or Regulatory Risk: Excessive Government regulations, archaic judicial and tax laws, and weak enforcement policies in countries you are investing in, can put your investments in a high-risk category.
Investing has now become a global phenomenon. Economies in different stages (developed, developing, or emerging) require different strategies to achieve growth. The flow and correctness of information in different markets are also vital to make correct decisions. Different countries may use different rules to convey financial information about companies being traded.
While investing in foreign stocks can provide a huge upside, investors also need to take into consideration that high returns always involve high risks. Never forget to keep in mind that your appetite for risk should be aligned with your short-term and long-term financial goals.