Premium Trap: Overseas ETFs Risk Capital for Indian Investors

Retail investors are increasingly allocating funds to international mutual schemes and ETFs, attracted by their higher returns compared to local equities over the past year. However, many of these popular overseas ETFs are currently trading at a substantial premium of 20-25% to their net asset values, exposing investors to potential sharp reversals.

The Reserve Bank of India's mandated overseas investment limit for mutual funds, capped at $7 billion, has led to many schemes being closed for fresh subscriptions. This has intensified demand for ETFs, which trade on exchanges and are now being bought at significant premiums over their daily prices.

Experts warn that investors are blindly purchasing these ETFs without assessing the premium. For instance, specific ETFs like Nippon India Hang Seng ETF and Mirae Asset Hang Seng Tech ETF are trading at premiums of 21% and 23% respectively. This premium is driven by the inability of ETF issuers to create new units to meet demand, while investors can still trade in the secondary market.

These overseas funds have significantly outperformed Indian markets, with international funds averaging 28% returns in the last year against Nifty's 12.8%. Investors seeking alternatives are also constrained by RBI limits on US-focused funds. Bypassing these curbs via the Liberalised Remittance Scheme involves high costs, and investing in GIFT City funds requires a substantial minimum investment of $5,000.

Investors buying international ETFs on secondary markets face a considerable risk. If the RBI were to lift or increase the overseas investment limits, the current high premiums on these products could quickly disappear, potentially leading to immediate capital losses of 20-25% for these investors.