Curbs on international funds – what you need to know

About a week ago, we had written on two of our recommended funds – Motilal Oswal Nasdaq 100 FoF and Motilal Oswal S&P 500 Index Fund barring all fresh lump-sum investments. Over the weekend funds from the Franklin and Nippon India AMCs also appear to have disallowed any new investments. 

At play in these curbs on international funds are the RBI’s limits on overseas investments and SEBI’s rules. Here, we’ll list out the concerns you would be having over these limits, what they mean, and what you should do. 

Please note that this is a developing situation. It will change over the course of the coming weeks. We’ll do our best to keep this post updated based on developments but it may come with some lag, depending on whether we have clarity as well 😊 

At this time, given the confusion surrounding these moves, our aim is simply to clarify the nature of these recent developments and ease any worries you may have. We have responded the best we can with the limited communication available from both AMCs and AMFI or SEBI in this regard.

Please note that the information given here is subject to change. AMCs are expected to issue addendums in the coming week based on developments. We will be updating this article based on information flow. Individual addendums will be added for major AMCs at the end of this article.

Q1. What is all this about investment limits for funds investing overseas?

Foreign investments are regulated by the Reserve Bank of India. Think about the Liberalised Remittance Scheme, that applies to spends you may make on overseas travel or stocks you buy directly in foreign markets. The cap on these, in a financial year, is $250,000 for individuals such as you and me.

Obviously, since currency flows directly impact exchange rates, the RBI keeps a rein on the same – whether it is domestic investments overseas or the reverse, borrowing overseas, FPI flows, direct investments and so on.

And therefore, the RBI specifies the extent to which the mutual fund industry as a whole can invest in overseas instruments. The industry-wide limit today stands at US $7 billion for investing in foreign securities. These securities could be ADRs/GDRs, stocks, debt instruments including government securities, derivatives, MF units and REITs. In addition to this $7 billion limit, there is another cap of $1 billion on investments made in overseas ETFs.

These limits apply to the MF industry itself. 

Separately, SEBI itself specifies the maximum a particular AMC can invest overseas; presumably, this could be towards bringing some equitability among the AMCs. Accordingly, each AMC can invest up to $1 billion in overseas securities and $300 million in overseas ETFs. Note that the limits apply to investments being made in overseas securities – it does not apply to the AUM itself. Remember that a fund’s AUM is a combination of fresh inflows and investments made plus the price appreciation in the portfolio. We are talking of the former alone here. 

These limits – both industry-wide and AMC-specific have been revised over the years. The table below shows how caps have gradually moved up. All amounts are in USD.

It is the above investment limit that is close to being breached. As we understand, it is only the $7 billion limit on overseas securities that is the primary concern at this time, and not the ETF limit. Therefore, funds that directly buy overseas stocks, bonds, or MFs are those that appear to be hitting the pause button on fresh inflows. More on that in later Qs.

Q2. Why are concerns over these limits cropping up now?

The mutual fund industry as a whole itself has really come into its own, featuring decisively in the retail investor's investments, only after 2015. More specifically, diversifying into overseas markets gathered pace only over the past couple of years as awareness grew – and as the Nasdaq 100’s skyrocketing returns caught investor attention.

For example, the AUM of fund-of-funds investing overseas stood at Rs 24,427 crore as of December 2021. That’s quite the leap from the Rs 9,088 in December 2020 and even more so from the mere Rs 2,636 crore in December 2019.

And that’s not including funds that invest directly in overseas stocks, and funds that add a dose of international stocks in their portfolios. A quick use of our MF Screener shows about 35 funds (open-ended only) with overseas exposure of more than 5% of their portfolios – that’s about 1 in every 10 equity funds. As we noted in our article on NFO investing last month, 2021 saw a spurt in NFOs of funds with an overseas investment mandate.

Therefore, though the current limits of $7 billion in overseas securities and $1 billion in ETFs have been in place for years, the rapid swell of investor interest over recent times is pushing at these caps.

Q3. What are funds doing in the face of these limitations?

Motilal Oswal AMC appears to be the first to have taken any steps, disallowing new lumpsums and switch-ins in its key overseas funds and avoiding creation of new units in its ETFs. Others, such as Franklin Templeton AMC and Nippon AMC have also reportedly paused investments. ICICI Prudential AMC advanced the closure of its Strategic Metal and Equity FoF. 

However, the exact rules of these bans are not clear as there are no addendums that AMCs have published as yet. 

According to reports, these will begin flowing in this week. We’ll update this section based on what unfolds over the course of this week. As far as we can grasp, AMCs may end up doing some or all of these:

• Banning all new lump-sum investments and switch-ins, but allowing registering of new SIPs and continuation of SIPs already running.
• Banning all lumpsums, switch ins and new SIP registrations but allowing SIPs already set up to continue. An extreme variation of this would be to cancel current SIPs, but we have not as yet seen notifications to this effect.

However, going by a recent media tweet with an AMFI internal note, it appears that AMFI has stated that AMCs shall not make any incremental investments in overseas funds or securities beyond what is existing on February 1, 2022. The note states that this is for AMCs with mandate to invest in overseas securities without the optionality to invest in Indian securities (essentially applicable only to funds with mandate to primarily invest internationally and not domestic funds that have limited exposure to overseas markets). 

The above, in our interpretation could mean stoppage of any kind of inflows -  lumpsum, fresh SIP, exiting SIP or STP. However, clarity on this is awaited by way of individual AMC addendums.

Bear in mind that the above moves and concern here is only with funds that invest in overseas securities (see Q1 for what qualifies) and not overseas ETFs. As far as funds investing in overseas ETFs go, since the limit is not near concerning levels, there appear to be no investment restrictions so far.
Again, this is a developing scenario and clarity on what funds are planning to do will emerge over the next few days or weeks. Please also note – very importantly – that this affects only fresh investments in the fund. It does not impact any redemptions or investments already made.

Q4. What is the way forward for these funds? Will these funds shut down?

To put it very plainly – the industry-wide investment limit needs to be revised upward. RBI and SEBI, along with the MF industry need to work out the caps that could be put in place that would allow them to continue investing as per their mandate and without disrupting investor interests. From what we gather and based on media reports, there are consultations ongoing that could see an upward revision in the cap. Funds are unlikely to completely shut down, unless there’s absolutely no change in the investment limits; in which case, funds may look to merge with others instead of an outright closure.

Q5. Will performance of these funds be affected?

Well – to some extent, the ban on fresh inflows could impact performance. There are different aspects at play here. One, the nature of the fund. Two, the ability of the fund to juggle exposure within its existing portfolio. 

For funds that invest in MF units, the performance impact may be minimised as the underlying international fund has no restriction on accepting inflows and will continue to manage their portfolio as before. The domestic FoF will only have to meet any redemption requests. 

For funds that invest directly in overseas stocks – such as ICICI Pru US Bluechip or Nippon India US Equity Opportunities or Nippon India Japan Equity - it can have some bearing on performance. With no fresh inflows, funds may find it harder to pick up new opportunities especially in the ongoing correction or shore up any performance dips through inflows. Performance will depend on how well the fund is able to use its current corpus to capture market movements.

Q6. What about funds that invest only part of their portfolio overseas like Parag Parikh Flexi Cap?

This depends on each fund. Parag Parikh Flexi Cap has banned fresh lumpsums and SIP registrations, but existing SIPs will continue. As far as other funds that invest overseas go, what each will do needs to be seen.

If they do not restrict inflows, they can simply continue to invest in domestic stocks based on their strategies. For most such funds, the international portion does not dominate the portfolio. For Parag Parikh, for instance, the overseas allocation is within 30%, as is the case for DSP Value. Axis Growth Opportunities and Axis Special Situations come in at about 25% of the portfolio. ICICI Pru FMCG and Kotak Pioneer hold at about 17%. Therefore, these funds have enough portfolio room to invest fresh inflows in domestic markets. While the overseas exposure has given a return impetus, these funds are certainly not entirely without investment options. 

Besides, the overseas portion of the portfolio is not disappearing altogether – whether for Parag Parikh Flexi Cap or any other fund. It is just that these funds may not be able to increase holdings there; they will continue to hold investments made. At worst, the restrictions may limit the fund’s ability to average costs lower in these market corrections. As explained above, a fund can still juggle around with overseas exposure that is already part of the portfolio.

Also remember that all indications are that the investment limit will be revised in due course. Any impact, therefore, may be temporary.

Update on 11.03.2022: Parag Parikh Flexi Cap has withdrawn the suspension of fresh investments in the fund. Therefore, the fund will now open up for all investments - but note that it will not be able to make incremental investments in overseas stocks yet as the investment curbs remain in place.

Q7. What happens to my investments in these funds?

Your investments in funds that have restricted inflows will not be affected. The only impact on you is if you want to make additional investments in these funds, since that may not be allowed. You can continue to hold these funds. Nothing changes for you.

Q8. Should I reduce investments in overseas funds?

If it is only this news about limits and investment restrictions that is your concern – NO, do not rush into redeeming and reducing exposure or stopping any ongoing SIPs. 

As you now know, this is not a fund-specific event and does not mean your fund’s performance is poor. This is an industry-wide development, triggered due to RBI rules in its foreign exchange management. 

Diversifying overseas is a sound investment strategy. An industry development of an operational (and most likely temporary) nature does not detract from diversification benefits. It does not mean that investing in US markets, or developed markets or any other market is going to get you poor returns from now on. Your original investment argument in investing in the overseas fund of your choice continues to hold. If you already hold such investments, remain invested. At the cost of sounding repetitive, do not be spooked into exits simply because of a ban on fresh inflows.

Q9. What should I do if I want to invest overseas now?

There are a few options available. For one, you could pick funds that as of yet have not barred inflows – provided, of course, that these funds (and the overseas markets they invest in) are investment-worthy.

Two, you could go for funds that invest in overseas ETFs since the current restrictions do not extend to ETF investments. Again, ensure that the ETF meets your portfolio requirements and is a good one to diversify into.

Three, you could invest in domestic ETFs that have international indices as the underlying. There are two risks here - one, a sudden uptick in demand for these ETFs may not be matched by a supply. AMCs manage trading volumes by creating units to meet demand if needed. With restrictions on investing overseas, an AMC may be unable to accept fresh money directly into the ETF to create fresh units. Therefore, there is a risk that the ETF’s market price may move beyond the ETF’s underlying NAV. Read about the impact of NAV and market price deviation in this article. Two, it needs to be seen how the ETF will maintain its portfolio construct and reflect the underlying index weights correctly if it is unable to deploy fresh money to adjust weights.

Q10. What about international NFOs that have just collected money?

If the fund’s mandate was to invest in ETFs, it will not be affected and it can deploy the amounts collected as designed. If its mandate is to invest in stocks or overseas funds, then options are not exactly clear at this time – it could, for example, hold cash and deploy when the ban lifts. It could change its mandate to allow it to invest in ETFs temporarily and tide over the ban.

Please note that we will not be taking queries on the status of individual mutual funds other than those we have recommended. We will try our best to update the addendums of AMCs below, as and when it comes to our notice. You may refer to updates from individual schemes in the below list.

Curbs on international funds: fund-wise list