Locked out of global gains: What happens when Indian fund-of-funds hit their overseas limits

As global markets shine bright, Indian investors often look beyond domestic shores to diversify their portfolios. But what happens when the very funds meant to give them global exposure hit regulatory roadblocks? In recent years, the limits imposed by Indian regulators on overseas investments have repeatedly become a bottleneck — freezing new inflows and leaving investors waiting on the sidelines.

The regulatory cap on overseas investments

Sachin Jain, Managing Partner, Scripbox, explains, “India’s mutual fund industry is subject to regulatory limits on overseas investments. There is an industry-wide limit of roughly $7 billion, and each fund house has a limit of $1 billion. Furthermore, investments in overseas ETFs are limited to $300 million per fund, with an industry-wide limit of $1 billion.”

These ceilings are designed to control foreign exchange outflows and maintain financial stability, but they also restrict Indian investors’ access to international opportunities.

Jain said that once these limits are reached, the fund houses cannot accept new investments into their international fund-of-funds; only redemptions are allowed. This basically freezes new investment, especially when international markets are doing well and domestic investors are eager to gain exposure.

“The limit is not related to the fund's performance, but rather to the limits set by regulators. Investors who are looking to diversify across markets, sectors, and currencies will find themselves on a temporary basis waiting until either the regulator increases the limits on overseas investments or the fund corrects itself, allowing for more headroom for investment,” adds Jain.

In other words, the fund’s ability to take in new money depends not on how well it performs, but on a rulebook written by regulators — one that doesn’t change very often.

How investors are impacted when limits are reached

When overseas investment limits are hit or reached, immediate implications occur for the investor. New lump-sum investments will be stopped, and in many instances, normal SIPs into the affected schemes will also be stopped.

For investors, this means that their long-term systematic investment plans — which rely on consistency — suddenly come to a halt.

This then disrupts the primary benefit of systematic investing — rupee-cost averaging — which allows for volatility and becomes available over time. Generally, this situation arises during favourable global market conditions, and investors are eager to allocate to high-potential or globally diversified exposure.

Ironically, the freeze often happens just when international markets are performing well — leaving investors frustrated as they watch opportunities slip away.

Missing moving forward with allocation during these times may involve accepting a missed market opportunity. Moreover, it confines the investor’s ability to improve their portfolio, especially when market national exposure could be considered risky.

“While redemption would still be open, the addition of further capital, which would enhance a strategy for allocation, could not occur. For long-term investors trying to build sustainable global exposure, there can be a cost to having these paused opportunities for compounding/allocating,” said Jain.

This delay can be costly. Every missed month in systematic investing is a lost opportunity for compounding — especially in high-performing global markets like the US.

So how do fund managers deal with this delicate situation — ensuring compliance while still looking out for investors’ interests?

"From an investor’s perspective, it’s important to understand the dynamics at play. When the overseas investment limits are close to being reached, asset managers typically act with caution. They often restrict lump-sum investments first while allowing SIPs to continue as long as possible, maintaining fairness and consistency for long-term investors," said Jain.

This phased approach ensures that small investors with ongoing SIPs are not immediately cut off from exposure, though eventually, even those can be paused if the limit remains breached.

However, these regulatory caps also limit the flexibility of asset managers to capitalise on global market opportunities. Global diversification works on the principle that while one market may be performing well, another may not.

"For instance, the US markets have performed strongly in recent years, whereas Chinese markets have underperformed over the past four years. Ideally, an investor could use such market cycles to average out their exposure or invest more in underperforming markets to benefit from potential recovery. But when the overall overseas investment limit is breached, such reallocation or averaging into markets like China becomes impossible," explained Jain.

This creates a strange paradox — fund houses have the skill and strategy to rebalance portfolios, but their hands are tied by regulation.

As a result, investors are effectively deprived of these strategic opportunities. "Asset managers, meanwhile, must strike a delicate balance between staying compliant with regulations and preserving investors’ long-term global diversification goals, often having to maintain existing exposures instead of dynamically reallocating across geographies or asset classes," added Jain.

Until regulators expand the overseas investment window, investors will need patience — and perhaps a touch of luck — to catch the next wave of global growth when the limits reopen.