One of the best ‘mantras’ of investing is finding opportunities that are sure to grow at a rapid pace. Be it equity or real estate or gold, if you know that the prices are going to rise, then you will try to buy and hold for some time. Talking about equity investing, emerging markets offer great opportunities to earn potentially high returns. Here, we will talk about emerging markets and the features and benefits offered by Emerging Market Funds.
What are Emerging Market Funds?
Emerging Market Funds are equity funds or exchange traded funds (ETFs) which invest in stocks of developing countries. By definition, an emerging market is a country which is developing and is on track to becoming a developed country soon. The four largest emerging markets in the world are India, Brazil, Russia, and China. While these markets might offer high growth rates, the risks are higher too. Investing through an Emerging Market Mutual Fund allows you to spread the risk by limiting your exposure to a single stock or country.
How do Emerging Market Mutual Funds Work?
An emerging market fund invests in a diverse collection of stocks spread across different countries, sectors, and market capitalizations. For example, an emerging market fund might decide to allocate 25% of its stocks to China. Further, it might spread this across banking, petroleum, and power sectors in China and focus more on mid-cap companies in these sectors. Similarly, it can determine the securities selection for each country. Hence, the fund is highly diverse and offers an opportunity to earn from the growth of the economy.
Who should invest in an Emerging Market Fund?
Emerging Market Funds carry high levels of risks. Further, economies can take years to develop. Therefore, these funds are recommended to investors with a high tolerance for risk and a long-term investment horizon (8 years and more). The funds are ideal for growth investors seeking investment opportunities in the global markets.
Factors to consider before investing in Emerging Market Funds in India
Here are some important aspects that you must consider before investing in emerging market funds in India:
Risks and Returns
Since emerging market funds offer rapid growth potential, there are several risks that come along with them:
- Inflation Risk – In emerging economies, fast economic growth can often lead to inflation.
- Currency Risk – Since the economies of emerging countries are volatile, fluctuations of their currencies against the US Dollar can lead to volatility in the investments made in those currencies.
- Liquidity Risk – Usually, the trading volumes of emerging economies are not as high as their developed counterparts. Hence, there is always a risk of liquidity.
- Institutional Risk – In emerging countries, regulations are still being formed and implemented which makes it difficult for fund managers to make informed decisions.
- Political Risk – Growing countries have inherent political instability which can put an added pressure on the performance of stocks.
While investing in emerging markets can offer tremendous growth opportunities, you must consider the risks before investing.
Expense Ratio is a small percentage of the total assets of the fund charged by the fund house towards fund management services. You must ensure that you find a fund with a lower expense ratio so that you can maximize your gains.
Invest according to your Investment Plan
Being a part of an emerging market, investors in India have a first-hand experience of the ups-n-downs that markets in emerging economies go though. However, there are some smaller emerging markets which offer great growth potential. It is important to diversify your portfolio and invest a small portion in emerging market mutual funds. This is akin to backing an underdog hoping that it will win. While emerging countries will develop sooner or later, staying invested in the right selection of stocks is essential. Hence, research the fund and the fund manager well before investing.
Being an equity fund, emerging market mutual funds are subject to capital gains tax.
Capital Gains Tax
Like other mutual funds, emerging market mutual funds will also attract capital gains tax depending on the holding period. Simply put, holding period is the time period for which you remain invested in the mutual fund. The holding period ends once you redeem your funds.
As per holding period, the units redeemed can attract STCG ( Short term capital gains ) or LTCG ( Long term capital gains). Let us see what they are :-
- Short Term Capital Gain (STCG) – Your investment earns short term capital gains if your holding period is upto 1 year. The STCG tax rate is 15%.
- Long Term Capital Gain (LTCG) –Your investment earns long term capital gains tax if the holding period extends beyond a year. LTCG does not apply upto Rs 1 lakh. Above Rs 1 Lakh, the long term capital gains are taxed at10% without indexation benefits.