How Foreign Assets In Your Portfolio Can Protect It From Volatility

Even during the ongoing global market rout, the importance of being internationally diversified has been validated. An Indian investor with exposure to the US market would have enjoyed downside protection over the shorter term and outperformance over the longer term (see table).

Once an Indian investor has adequate exposure to the domestic market, he should diversify internationally. “Just as it is a good practice to diversify across sectors and companies, it is important to diversify across markets as well. If you do so, your portfolio will be less affected by risks specific to your home market,” says Kunal Bajaj, head of wealth management, MobiKwik.

The Indian economy and markets, for instance, tend to be hit hard by high oil prices. Many foreign markets, say oil exporters, tend to outperform in such times and can act as a hedge in the Indian investor’s portfolio.

International diversification is also essential to get exposure to sectors and companies not available on the Indian bourses. Financial advisors suggest the US market should be your first stop when you venture abroad. “The US is the world’s largest stock market, accounting for about 50 per cent of the global market cap. It also has a low correlation with the Indian market,” says Pratik Oswal, head of passive funds, Motilal Oswal Asset Management Company.

The data over 15 years shows the correlation between the Nifty50 TRI and the S&P 500 TRI is just 0.15. Assets with low correlation offer good diversification when combined in a portfolio.

Exposure to the US market will allow you to partake of not just US but global growth. “Most constituents of the S&P 500 index are multinationals. About 45 per cent of their revenue comes from global markets,” says Oswal.

US funds are dollar-denominated. Taking exposure to them will offer protection against long-term depreciation of the rupee against the dollar. The rupee has depreciated at an annualised rate of about 3 per cent against the dollar over the past 20 years. With so many expenses, it has become imperative to have exposure to this asset class.

Indian investors now have three options in the US market: An index fund based on the S&P 500 index, an exchange-traded fund, and fund-of-fund based on the Nasdaq 100 (both from Motilal), and several actively managed funds. “The S&P 500-based index fund is the lowest risk option, as the investor gets exposure to a diversified basket of large-cap stocks,” says Vishal Dhawan, chief financial planner, PlanAhead Wealth Advisors. While the Nasdaq 100 index has been an outperformer in the past, it is a tech-heavy index that is riskier due to its sector concentration.

Most US-focused active funds available in India have a growth-oriented investment strategy that has done well in the past. Choosing the right active fund manager is always a challenge. Dhawan suggests building your initial core allocation via the S&P 500 index fund, and only then considering other options.

The US market is not inexpensive currently. A lump-sum investment could prove risky if that market sees a precipitous decline, or if the dollar weakens, which could happen due to any of these factors —massive liquidity injection by the US Federal Reserve, an economic downturn, or political uncertainty around election time. “Build a 10-20 per cent exposure over 24-36 months using the systematic investment plan route,” says Dhawan.