Your Questions Answered: Nasdaq 100 vs. S&P 500—Which index is better for investing?

Q. We have been investing through SIP in large-cap and index mutual funds for the past 8 years. We now intend to diversify our portfolio and invest in the international mutual fund schemes of Indian mutual funds houses. Please elaborate on the pros and cons of investing through SIP in international mutual schemes of domestic mutual fund houses. Separately, our acquaintances have suggested to us that we invest in NASDAQ 100 and S&P 500 tracking mutual funds. Can you tell us the major differences between the two?

Sriram Teneti, Ulsoor, Bengaluru

Introduction

Investing in international mutual fund schemes offered by domestic mutual fund houses in India can be a strategic move for investors looking to diversify their portfolios and tap into global growth opportunities. These funds provide exposure to international markets, allowing investors to benefit from the performance of foreign companies and economies.

What are international mutual funds?

International mutual fund schemes of domestic mutual funds houses which in accordance with Securities and Exchange Board of India (SEBI) regulations invest in (a) equity of companies listed abroad, (b) American Depository Receipts (ADRs) and Global Depository Receipts (GDRs) of Indian companies, (c) debt of companies listed abroad, (d) Exchange Traded Funds (ETFs) of other countries, (e) units of passive index funds in other countries, (f) units of actively managed mutual funds in other countries. Additionally, under the SEBI regulations, they are allowed to invest in Indian equity and debt securities.

Pros of investing in international mutual funds

There are a number of benefits associated with investing in international mutual funds schemes through SIP, we have listed the key benefits below:

1. Geographic diversification: One of the primary benefits of investing in international mutual funds is geographic diversification. By investing in companies outside of India, investors can spread their risk across different markets and economies. This diversification helps reduce the impact of any single country's economic downturn on the overall portfolio. It provides a hedge against domestic market volatility and enhances the stability of the investment portfolio.

2. Access to global leaders: International mutual funds allow investors to gain exposure to some of the world's leading companies that are not listed on Indian stock exchanges. These companies include global giants like Apple, Amazon, Google, and Microsoft. Investing in these companies can provide significant growth potential and access to innovative industries and technologies that may not be available in the domestic market.

3. Currency diversification: Investing in international mutual funds also offers the benefit of currency diversification. By holding assets denominated in foreign currencies, investors can potentially benefit from favorable currency movements. For example, if the Indian Rupee depreciates against the US Dollar, the value of investments in US-based assets may increase when converted back to Rupees. This can provide an additional layer of returns and help mitigate currency risk.

4. Enhanced growth opportunities: International markets often present unique growth opportunities that may not be available in the domestic market. Emerging markets, in particular, can offer high growth potential due to rapid economic development and increasing consumer demand. By investing in international mutual funds, investors can tap into these growth opportunities and potentially achieve higher returns.

5. Professional management: International mutual funds offered by domestic mutual fund houses are managed by experienced fund managers who have expertise in global markets. These fund managers conduct thorough research and analysis to identify attractive investment opportunities and manage the portfolio effectively. Investors can benefit from the professional management and insights of these experts, which can enhance the overall performance of the fund.

6. Regulatory oversight: Investing in international mutual funds through domestic mutual fund houses provides the advantage of regulatory oversight by the SEBI. SEBI's regulations ensure that these funds adhere to strict guidelines and maintain transparency in their operations. This regulatory oversight provides an added layer of security and confidence for investors.

7. Rupee Cost Averaging: SIP allows investors to benefit from rupee cost averaging (RCA). When you invest a fixed amount regularly, you buy more units when the market is down and fewer units when the market is up. This averaging effect reduces the impact of market volatility and lowers the average cost of investment over time. It helps in mitigating the risk of timing the market and ensures that you invest at different market levels.

8. Power of compounding: It is one of the most significant advantages of SIP. When you invest regularly over a long period, the returns generated on your investments are reinvested, leading to exponential growth. The longer you stay invested, the more you benefit from compounding. SIPs are ideal for long-term wealth creation and can help you achieve your financial goals.

9. Affordability: SIPs make investing affordable for everyone. You can start with a small amount, as low as ₹500 per month, and gradually increase your investment as your financial situation improves. This affordability makes SIPs accessible to a wide range of investors, including those with limited financial resources.

Cons of investing in international mutual fund

One should keep the following things in mind before availing home loan:

1. Currency risk: Fluctuations in exchange rates can significantly impact the performance of international funds. A strengthening of the Indian Rupee against foreign currencies can reduce the returns on investments made in those currencies.

2. Political and economic risks: International investments are exposed to political instability, economic downturns, and geopolitical tensions in foreign countries. These factors can negatively affect the performance of international mutual funds.

3. Higher fees: International mutual funds often have higher expense ratios compared to domestic funds. This is due to additional costs associated with investing in foreign markets, such as currency exchange fees and foreign custody fees.

4. Complexity: Investing in international funds can be more complex than investing in domestic funds. Investors need to understand the nuances of foreign markets, including different accounting standards, regulatory environments, and tax implications.

5. Taxation: The tax treatment of international mutual funds can be different and sometimes less favourable compared to domestic funds. Investors need to be aware of the tax implications and any changes in tax laws that may affect their investments.

6. Market timing and liquidity: International markets operate in different time zones, which can make it challenging to time the market effectively. Additionally, some international markets may have lower liquidity, making it harder to buy or sell investments quickly.

Differences between Nasdaq 100 and S&P 500

Let's explore the major differences between the Nasdaq 100 and the S&P 500 from an index mutual fund perspective.

1. Composition and sector allocation

Nasdaq 100:

• The Nasdaq 100 index includes the 100 largest non-financial companies listed on the Nasdaq stock exchange.
• It is heavily weighted towards the technology sector, with tech giants like Apple, Microsoft, Amazon, and Alphabet (Google) among its top holdings.
• Other significant sectors include consumer discretionary and healthcare, but the index has minimal exposure to financials and industrials.

S&P 500:

• The S&P 500 index comprises 500 of the largest publicly traded companies in the United States, listed on various stock exchanges.
• It offers a broader representation of the U.S. economy, with significant allocations to sectors such as information technology, healthcare, financials, consumer discretionary, and industrials.
• The index is more diversified across different sectors compared to the Nasdaq 100, reducing the concentration risk associated with any single sector.

2. Market capitalisation

Nasdaq 100:

• The Nasdaq 100 is a market-capitalisation-weighted index, meaning that the largest companies by market cap have the most significant influence on the index's performance.
• The index tends to have a higher concentration of large-cap growth stocks, particularly in the technology sector.

S&P 500:

• The S&P 500 is also a market-capitalisation-weighted index, but it includes a broader range of companies across various sectors.
• The index includes both large-cap growth and value stocks, providing a more balanced representation of the overall market.

3. Performance and volatility

Nasdaq 100:

• Historically, the Nasdaq 100 has delivered higher returns compared to the S&P 500, driven by the strong performance of technology stocks.
• However, the index is also more volatile due to its concentration in the tech sector, which can experience significant price swings.

S&P 500:

• The S&P 500 tends to have more stable performance due to its diversification across multiple sectors.
• While it may not offer the same high returns as the Nasdaq 100 during tech booms, it provides a more balanced risk-return profile.

4. Investment objectives

Nasdaq 100:

• Investors seeking high growth potential and willing to accept higher volatility may prefer the Nasdaq 100 index mutual funds.
• These funds are suitable for those looking to capitalise on the performance of leading technology and innovative companies.

S&P 500:

• Investors seeking broad market exposure with a balanced risk-return profile may prefer the S&P 500 index mutual funds.
• These funds are ideal for long-term investors looking for steady growth and income from a diversified portfolio

Taxation of international mutual funds

Classification of international mutual funds:International mutual funds are typically classified as debt funds for taxation purposes in India. This classification is based on the proportion of their investments in foreign equities versus domestic equities. If a mutual fund invests more than 65% of its corpus in non Indian equities, it is treated as a debt fund for tax purposes.

Taxation of capital gains: The taxation of capital gains from international mutual funds depends on the holding period of the investment:

• Short-Term Capital Gains (STCG)
  If the units of the international mutual fund are held for less than 24 months, the gains are considered short-term capital gains. STCG is taxed at the investor's applicable income tax slab rate.
• Long-Term Capital Gains (LTCG)

If the units are held for more than 36 months, the gains are considered long-term capital gains. LTCG is taxed at a rate of 12.5%.

Tax planning strategies

Investors can adopt various tax planning strategies to optimise their tax liability on international mutual fund investments:

• Long-term investment: Holding investments for more than 24 months can help reduce the tax burden by qualifying for long-term capital gains tax rates.
• Dividend reinvestment: Opting for dividend reinvestment plans can help defer tax liability on dividends and potentially benefit from compounding returns.
• Tax-efficient funds: Choosing tax-efficient international mutual funds that focus on growth rather than income distribution can help minimise tax liability.

Conclusion

Investing in international mutual fund schemes offered by domestic mutual fund houses in India can provide numerous benefits, including geographic and currency diversification, access to global leaders, enhanced growth opportunities, professional management, and regulatory oversight. By incorporating these funds into their investment portfolios, investors can achieve a well-rounded and diversified investment strategy that leverages the growth potential of global markets.

Disclaimer: Investing in mutual funds involves risks, including potential loss of principal. Please consult with a financial advisor before making any investment decisions.

Kuvera is a free direct mutual fund investing platform.