Whenever Indian AMCs bunch up their launches of NFOs (New Fund Offers) on any particular theme, it is usually a bad time to invest in that theme. A good recent example of this is the international and US-centric equity funds launched in 2021. The months from January to December 2021 saw the launch of over 20 Fund of Funds and Exchange Traded Funds (ETFs) that promised to open the doors to international investments ranging from Taiwanese equities to FAANG stocks. But with global markets melting down, these international funds are down by between 10% and 30% from their peak values.
Impressive trailing returns from Nasdaq and US equity funds had also prompted many Indian investors to add to their allocations of older international funds from 2020 to 2021. But SEBI rules restricting fresh investments in international funds have halted those investments as well. With fears of a global slowdown and US recession taking hold, many investors are asking the question – what should I do with my international funds? This FAQ attempts answers.
FAQs: What should you do with international funds
Q Why are my international funds giving negative returns?
International stock markets have been correcting sharply on fears that a perfect storm of events will hurt global economic growth this year and the next. With the Russia-Ukraine conflict creating severe supply shortages in a range of commodities from oil and natural gas to wheat and cooking oils, inflation has been rapidly rising around the world. Rising inflation, with its implications for consumer spending, has put a speed-breaker in the way of global economies recovering from the pandemic.
At the same time, China, the fastest growing global economy and largest consumer of commodities in the world has also been sliding down a slippery slope on problems of its own making, ranging from an over-leveraged real estate sector to a ‘zero-Covid’ policy that has led to severe lock-downs of its major industrial towns. The gloomy growth outlook coincides with global central banks, led by the US Federal Reserve aggressively raising interest rates and reversing their money-printing policies, to tame inflation. Rising rates are again not good for consumer spending, investments or corporate earnings.
The IMF, in its recent July World Economic Outlook has sharply cut its GDP growth projections for most countries, especially advanced economies. But given that a majority of global institutional investors are headquartered either in the US or EU, the slowdown has had them cutting back on trade and pulling out money from other markets, leading to capital outflows, currency depreciation and economic woes in emerging markets too.
Stock prices are after all slaves to earnings. Global stock markets have therefore corrected sharply since the beginning of 2022, on expectations of global GDP growth slowing sharply, liquidity drying up and interest rates rising. It is this stock market performance that reflects in international fund returns. But the Indian stock market has been among the better performers in this period, with domestic flows into equities providing a floor even as FPIs have been in pullout mode from October 2021 to June 2022.
Q Why have US stock markets fallen more than others?
US stock markets have registered steeper falls for three reasons. One, the US economy is expected to see the sharpest slowdown among the advanced economies with some even expecting a recession (contraction in the economy) this year or the next.
Two, US has been facing a spell of exceptionally high inflation in fuel and food prices, with retail inflation climbing steadily from 7.9% in February 2022 to 9.1% by June 2022. As US is a consumption-driven economy, with 70% of its GDP coming from consumer spending, it faces particularly high risks from rising inflation pressuring households.
Three, among the global central banks, the US Fed has been the most aggressive in hiking interest rates to tame inflation. after initially asserting that inflation is transitory, it has hiked up its policy rate (Fed Funds Target rate) by 225 basis points in 2022, taking the policy rate up from near-zero to 2.25-2.50% in just the last four months. Markets expect another 100-basis point hike, taking this rate to 3.25-3.5% by December 2022. Consumer spending and the housing market boom in the US are largely financed by loans. There’s therefore the fear that this sudden spike in rates could spark off housing loan defaults in the coming months, landing the US economy in trouble.
In fact, with US reporting a small contraction in real GDP for the recent January-March and April-June 2022 quarters, it is already in a technical recession. But both the Biden government and US Fed appear to be in denial about it. In its recent meeting in end-July, the Fed hiked its target rate by 75 basis points and swore that it would do whatever it takes to bring inflation down to its comfort zone of 2%. (See the FOMC statement here)
The US and global stock markets have latched on to Powell’s statement that the quantum of future hikes would be data-dependent to infer that the Fed would slow or pause rates in future. This appears quite unlikely, given that the US June inflation print was at 9.1%, while the Fed’s comfort zone is at 2%. Right now, there appears to be a high risk that in its effort to wrestle down inflation to 2% with its rate hikes, the Fed will speed up the US economy’s journey towards a recession.
Q Recession risks hold for all stocks. Then why have US technology stocks, and tech indices like the Nasdaq100, fallen much more than other indices?
The US technology giants received a huge lift to their business and profits during Covid as demand for e-commerce services, OTT streaming, cloud services, work-from-home solutions and so on boomed. With the Covid effect wearing off, this one-off demand is expected to wane, leading to a sharp slowdown in the earnings of the tech companies. Globally, regulators are also beginning to tighten the screws on Big Tech, adding further pressure to their revenue and earnings outlook.
When interest rates rise, stocks trading at high PEs face the most risk of de-rating. As US Big Tech and FAANG stocks were the most expensive and hyped-up in the earlier bull market, they’ve also faced the brunt of de-rating in the bear market that has followed. The market sharply lowering its growth expectations from tech stocks, reflects in the much sharper shrinkage in the price-earnings ratio of the Nasdaq 100 compared to the US S&P 500.
Q But international funds also make their returns from the Rupee depreciating against other currencies. So, what’s the view on that?
Yes, the returns that Indian investors make from investing in international funds is a combination of stock market returns in the underlying country or asset and the movement of the foreign currency against the Rupee. As most India-based international funds invest in dollar-denominated assets overseas, it is US dollar’s exchange rate against the Rupee that matters to returns.
Usually, during global crises, FPIs pull out money from India, leading to the Rupee sliding against the dollar. Investors in international funds are cushioned against this movement to some extent because of the US dollar appreciating. It is also a fact that the US Dollar has displayed its strength and appreciated against most global currencies during every major global financial crisis in recent decades - whether it is was 9/11 or the Lehman collapse or the 2013 taper tantrum.
This is because the US is the home market for a majority of global institutional investors like mutual funds, pension funds and hedge funds. When crisis strikes, these investors like to pull out money from less-known markets and re-invest it back home, in US government bonds. This usually leads to the US dollar strengthening even if the US economy is in poor shape.
This has played out in 2022 too. The US Dollar index, which captures the movement of the US dollar against six leading global currencies is up by nearly 10% on a YTD basis and 14.6% in the last one year. Given the relative strength of the Indian economy, the Rupee has not fared too badly against the US Dollar, depreciating by 5.6% YTD and 6.1% in the last one year. This is likely to have reduced the negative returns for Indian investors from their international funds.
Going forward, India’s current account deficit is expected to widen. But the Indian economy will not only register the strongest growth in 2022 and 2023, but is also acknowledged to be a well-managed economy compared to its emerging market and South Asian peers. India’s central bank, which is sitting on $590 billion of forex reserves even after recent depletion, is well placed to defend the currency against speculative attacks. Therefore, though the Rupee can continue to depreciate against the dollar, the depreciation may be gradual and not dramatic.
Q Going by all this, India appears better placed than most other global markets, both in terms of the economy and the currency.
That’s quite true. India is better placed for three reasons. One, as India’s economy is mostly domestically driven and not export dependent, the prospect of a global slowdown doesn’t affect its GDP growth prospects much. Two, India is facing lower inflation risks than economies like the US, because it is largely self-sufficient on food and dairy. The only source of inflation worries for India lies in crude oil, natural gas and energy complex for which it is import dependent. Three, unlike Western economies, the Indian government did not splurge too much on stimulus packages during Covid and left it to RBI to do much of the liquidity pumping.
Nor is the Indian government a big borrower in foreign currency. RBI has been well ahead of other central banks in withdrawing the liquidity infusions given during Covid. Thanks to all this, the Indian economy does not face high risks from inflation or sovereign debt default. The only risks for it, come from high energy prices and foreign investor pullouts.
Q If I've invested a lot in international equity funds in the past 2-3 years, what should I do?
You can do three things. One, if you’ve invested in non-US centric international funds, we don’t recommend them. While the US economy draws its strength from being the go-to safe haven for global investors, other economies – whether advanced or emerging- don’t offer this advantage. With their economic outlook expected to turn distinctly worse in the next couple of years, remaining invested in non-US international markets is not a good idea. This earlier article explains why we view US centric funds as the best bet for international investors.
Two, given that India’s economic outlook and earnings prospects appear brighter than elsewhere right now, it would be best to reduce your overseas allocations to 10-15% of your equity portfolio, while using Indian equities as your mainstay. Three, if you’ve been making 10-15% of your equity allocations into US-centric funds in the last 2-3 years, but have stopped recently, you must resume your investments through the SIP route, in funds that currently allow fresh investments. Having invested in US markets during the bull phase, averaging your costs down now is very important for your long-term returns. US stocks have turned much cheaper now than a year ago.
Q There are still SEBI restrictions in place on international funds accepting new money. So which US-centric funds can I SIP in, now?
At this time, our recommendation in Prime Funds is Kotak Nasdaq 100 ETF FoF, as international funds investing in ETFs are currently open for investments. You can consider international ETFs like the Mirae Asset S&P 500 Top 50 ETF, although tracking error is likely to remain on the higher side owing to restrictions.