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International mutual fund (MF) schemes, previously restricted from investing directly in foreign instruments, are now directed to cease accepting fresh investments in schemes that invest in overseas exchange-traded funds (ETFs).
The Securities and Exchange Board of India (Sebi) has issued a directive to fund houses through the Association of Mutual Funds in India (Amfi), citing a near breach of the $1 billion ETF investment limit, said MF executives.
The directive comes into force from April 1, 2024.
Data from Amfi shows that 13 international MF schemes invest in international passive funds (ETFs and index funds), collectively managing Rs 7,743 crore. Additionally, many other MF schemes allocate a small portion of their corpus to international ETFs.
The restrictions on foreign ETF investing block the sole international investment route available after the complete utilisation of the $7 billion non-ETF investment limit in January 2022.
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Since then, MFs have been allowed to make fresh investments only when redemptions create fresh room for deployment. In the past two years, MFs have intermittently opened their international schemes for short periods whenever there is investment headroom.
Sebi and some MFs have made representations to the Reserve Bank of India (RBI) seeking new limits, but the central bank has yet to make a decision.
In January 2024, RBI Governor Shaktikanta Das said that the decision would be made once the central bank is confident that the currency is stable on a durable basis.
A large fund house recently proposed to the RBI to link the international investment limit to India’s foreign exchange reserves.
MF executives do not expect the limit to increase before the elections.
“It was only a matter of time for the limit to be used up. $1 billion is too small for a $650 billion industry. An increase in the limit seems unlikely before the elections,” said an MF executive.
The assets under management (AUM) of international MF schemes have modestly increased in the past two years, growing to Rs 24,700 crore (as of February 2024) from Rs 22,700 crore in January 2022.
AUM growth is subject to both mark-to-market gains and flows. Despite the strong performance of the US market in the past year, money has mostly been flowing out of MF schemes in the past year. MF executives attribute this flow reduction to both the restrictions and the change in taxation in April 2023.
Before March 2023, international schemes, along with debt funds, enjoyed indexation benefits. Now, returns are taxed at the investor’s slab rate.
