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Should you invest in international funds?


October 15, 2020

These days, investors in India have an increasing number of options for investing internationally (global funds, feeder funds, overseas indices, and even direct stocks!). So, it’s not surprising that a lot of you are beginning to wonder if you need to add international exposure to your portfolio. Let’s see if it is necessary to diversify into international markets. And if yes, should it be through stocks or mutual funds.

At the outset, let’s be clear about one thing: It is not ESSENTIAL for an Indian investor to diversify into international stocks. Even with its recent economic setbacks, India remains a growth market with good wealth creation opportunities in both stocks and bonds. But international diversification can fulfil specific objectives for informed investors. There are five arguments in favour of Indian investors diversifying into international equities (either through funds or stocks). You can judge if they apply to you.

investing internationally

# 1 More opportunities

If you’re one of those people who likes to examine every bit of merchandise across a dozen retail stores before plonking your money on a single shirt, then the ‘wider canvas’ argument on international investing will apply to you.

India has a listed universe of 5000-odd stocks, but its market capitalisation of $ 2.1 trillion accounts for barely 3% of the total capitalisation of global stock markets. This suggests that there’s 97% of the equity canvas waiting for you, if you look beyond India. Many globally large industries do not have a representation in the Indian listed universe either. Think of a renewables proxy like Tesla, an electronics giant like Samsung, ecommerce behemoth like Alibaba or defence and aerospace leader like Boeing – there are no parallels in India. So if you have a particularly understanding of such sectors or your investment philosophy is all about owning best-in-class firms in any sector, international investing will make sense for you.  

# 2 Sunrise sectors

Some equity investors are happy with a 15% return as long as they don’t go through wild swings in portfolio value. Others are willing to risk capital losses for multi-baggers.  Adventurous investors may find that the Indian listed universe is somewhat restrictive for folks who like to bet on sunrise sectors that they think will mint money over the decade or so. Want to bet on a company that’s in Covid vaccine development? Keen to own tech firms in the thick of Machine Learning/Artificial Intelligence research? Looking for firms that are acing online learning? Want to invest in recession-proof ‘vice’ businesses minting money from betting or marijuana? You’d be hunting for a needle in a haystack if you try to find such companies in India.

Thanks to SEBI specifying stringent profitability criteria and compulsory institutional participation for companies to go public in India, companies in a very early stage of growth or those in dicey businesses often stay away from public markets. Increasingly, companies grabbing a significant share of the Indian consumer’s wallet – the Olas, Swiggys, Dunzos and Byjus – are also staying in the private domain as they’re able to source ample venture money right from the startup to high growth stage. If you’re an adventurous investor who is willing and able to assess the prospects of firms in sunrise businesses in a global context, diversifying into more liberal markets such as the US or UK may be fruitful, as you’ll find representation from every niche sector and theme.

# 3 Smoother journey

One of the basic reasons for diversification is to smooth out volatility of returns by holding assets that do not move in the same direction. Though it may appear so, stock indices of different countries do not move in tandem. 2015 was a negative year for the Sensex, but the European and Japanese indices closed the year in the green. In 2017, a great year for the Sensex with a 28 percent gain, its return was bettered by China’s Hang Seng with a 36 per cent return. Because global investors have a home-country bias, markets such as the US often fall far less than emerging markets like India, when global crises hit. When the tech bubble popped in 2000, the Sensex lost 21 per cent, but the US Dow Jones saw just a 6 per cent loss. In the Lehman year of 2008 the Sensex lost 52 per cent but the US got away with 34 per cent. Owning some exposure to stocks from more stable developed markets can help shield from downside in crisis years.

#4 Better bargains

Of late, the Indian stock market has regularly figured amongst the most expensively valued in the world. While the Nifty 50 PE hovers at a pricey 30 times, many global market indices are cheaper. In certain sectors such as consumption, automobiles, technology and engineering, Indian companies that are a fraction of the size of their global peers trade at premium or comparable valuations. Here are some comparisons.  

Global diversification may allow you to hunt for better value among global stocks, when Indian markets are in super-heated mode or specific sectors have been bid up to fancy valuations.

#5  Bet on the dollar

“Never bet against America” – Warren Buffet says. And an overwhelming proportion of his wealth has come from putting his money where his mouth is – investing in great American companies through good and bad times. For Indian investors too, having a portion of their portfolios invested in dollar-denominated assets can provide a leg-up to portfolio returns.

In early 1994, the Rupee traded at 31.3 to a US dollar. By January 1999, it had slipped to 42.5. In January 2004, the exchange rate was 45.2 and five years later it slipped further to 48.8. Today, it’s at 73.2.  With the Rupee depreciating at the rate of 3-4% a year, Indian investors who held US stocks or US assets in the past two decades have seen their portfolios outperform purely domestic portfolios by this margin. Safe-haven demand for dollar whenever crisis strikes and India’s dependence on FPI flows for capital ensure that every time there’s a crisis, the Rupee weakens sharply against the dollar. 

Diversifying into dollar assets also makes helps your portfolio when macro risks loom large – be it escalating oil prices, global rate hikes or FPI pullouts from emerging markets. Investing in overseas stocks, particularly dollar-denominated ones, helps you convert the challenge of Rupee depreciation into an investing opportunity to earn better returns. If you travel abroad frequently, have children studying overseas or maintain relatives abroad, Rupee depreciation can cut a big hole in your pocket every time you remit foreign exchange. Owning dollar assets in your portfolio by investing overseas can help hedge your portfolio against Rupee depreciation, if you have such expenses denominated in dollars.

If any of the above reasons to invest in international stocks appeals to you, you can consider a pre-decided portfolio allocation to them (say, 10-20%).

Investing internationally – Stock or fund route?

Should you invest directly in stocks or take the fund route? Well, understanding and analysing Indian businesses in the post-Covid world is hard enough, without attempting this with companies operating in markets we don’t fully understand. But if you know a sector inside out or are betting on a product or business that’s pretty straightforward, the direct approach may work. Do note that taking the direct stock route overseas means that you agree to comply with various laws from FEMA to RBI’s Liberalised Remittance Scheme(LRS) regulations. Lately such investments invite the attention of the taxman too. Also, while there are now a good number of brokerages that allow you invest in global stocks, do note that their brokerage and other charges are not the same as local charges and mostly higher.           

The fund route is easier way to acquire a portfolio of global stocks selected by a professional manager. Stick to funds that invest in US stocks, to make the most of the dollar advantage.  Stay off emerging market equities that behave very like Indian markets. 


Related : Review of Motilal Oswal S&P 500 Index Fund

For options to invest internationally through Mutual funds, check out our list of Prime Funds

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