A decade ago – friends and family in the US wanted to take advantage of the India growth story from abroad. Their investments in India over ten years ago have delivered good returns (10-12% yearly), but they are still upset about it? Why? The dollar has eroded all the gains they have made India. If they account for rupee depreciation – their returns are under 0.8%. The India growth story is well and alive – but rupee depreciation has led to investors to lose out on all the profits generated.
For Indian investors investing abroad – it s been a different experience. Global companies are doing better than ever – and the rupee depreciation has added a minimum of 3-5% every year to their returns. The S&P 500, for example, has delivered a performance of close to 18% yearly over the last decade in rupee terms.
It s becoming a common belief that returns alone should not dictate how one should invest. Investors realise that returns are uncertain and hard to predict. Merely choosing the fund with the highest returns – leads to average results over long-time periods. And what is also well documented is that top funds change every year.
So, if returns are not the best gauge then what else should investors look for?
Portfolio diversification – It s a common saying -“don t put your eggs in one basket.” What this means is that investors should ideally diversify their investments across different securities. It s the reason why mutual funds have become so successful. But this is still not entirely correct. The new theory should be to “buy multiple baskets.” Why? We have seen over the last two months that however, diversified one s investment is – equities fall together. Whether someone has invested in 5 or even 50 mutual funds, they have seen a decline in portfolios of over 25-40%. Diversification across asset classes (or buying multiple baskets) has proven to be effective in these times. If someone had diversified his/her investments in gold, international equities, debt and equities – their short-term portfolio loss would have been much lower.
How does international diversification fit into this? International investments have fallen less and over long-time periods have very low correlation with Indian equity markets. By taking out country risk – investors are making their portfolios less volatile. For example – correlation of international indices such as the NASDAQ and S&P 500 with Indian indices is less than 15%. What this means is that investors choosing to diversify with international funds can expect their portfolios to move differently to Indian indices (just like gold).
Why is dollar hedge important? Almost every working professional is spending in dollar terms today. We earn in rupee but pay in the dollar. We are buying Nike shoes, Apple/Android phones, Hyundai cars, and sending our kids to school outside India. For instance – The cost of education abroad has increased 2-3x over the last decade, and this is because of the rupee decline. Keeping spending in mind – its crucial to hold some proportion of investments in dollar-based investments.
Even going forward – the dollar will continue to appreciate over the rupee. As long as inflation in India is higher than it is in the US – the rupee will depreciate. Therefore – investors need to hedge their spending by adding international funds in their portfolio.
Global factors – Need for international diversification comes at the point where the world is becoming more global. In addition to our spending patterns – business models are getting a lot more global. We all use Flipkart, Amazon, Instagram, WhatsApp daily. Today a Maruti is competing with a Kia or a Hyundai. With these forces – it’s important for the investment portfolio to evolve with competitive trends. Having brands such as Amazon, Google, Facebook, Coca Cola in the portfolio enables investors to have the very best companies with them at all times. The Indian market is small in comparison to global standards and having global exposure allows investors to who grow with some of the biggest companies out there.
Chart 1: ‘As seen above, international diversification reduces portfolio volatility dramatically’
So how does one diversify? There are a lot of international funds ; S&P 500; NASDAQ in India currently being offered. By choosing index funds (most popular and proven to be effective), investors can ensure low fees while getting exposure to the best companies globally.
A sound asset allocation strategy based on the individual s risk profile is a great starting point. If a customer is purely looking at returns (which have been phenomenal), then there is a likelihood of him/her of being disappointed in the future. Advice would not to go all-in but build it in a way where an investor can have portfolio exposure of 5-10% in the next 1-2 years.
In conclusion, – investors should look beyond returns to allocate their investments in global funds. Diversification and dollar hedge should be on top of their minds.
Chart 2: “Returns in the last decade have been great.” However – returns alone should not be a deciding factor.”
