Why international diversification is necessary

By Morningstar |  08-10-20 | 
 

Dhaval Kapadia, Director – Portfolio Specialist, Morningstar Investment Advisers India, chats with Rishiraj Maheshwari, founder of RISCH Wealth and Family Office, about the benefits of international diversification.

Why is it necessary to have international equities in the portfolio?

India is a growing economy, barring for the last few years, during which growth has slowed down. Despite this, India contributes 3.3% to the global Gross Domestic Product, or GDP. Other countries such as the U.S. and China contribute 22% and 15% to the global GDP, respectively.

Each of these countries, given their size, offer some unique opportunities in their respective markets. For instance, the U.S. economy is driven by consumption and more recently by the technology sector. Germany and Japan are known for engineering excellence. China is known for manufacturing. There are multiple economies and markets where one can find different opportunities to invest into. The companies operating in these markets have a significant market share globally. One reason to diversify globally is to get access to these global opportunities on a large scale.

Further, it is difficult to predict which market or asset class will perform well each year. Over the last 12 years, if we compare the Indian equity market with global markets, Indian equities have been the best performing market for four of those 12 calendar years. U.S. equities have been the best performing market for three out of 12 years. India has also been among the worst-performing markets in four out of those 12 years as well. So other markets have performed well during those periods when Indian markets fell. Different markets present different opportunities during different points in time. It pays to be diversified across different markets to cash in on such opportunities.

Investing in other markets helps one diversify within equity as an asset class. This will help reduce the downside when one economy or market does not do well.

How has the Indian market performed vis-à-vis other markets?

Over the past ten years, Indian markets have generated an annualised return of 9%-10%. This includes large, mid and small caps. The returns from U.S. equities during the same period has been 20% annualised in rupee terms. However, this doesn’t imply that U.S. equities will generate the same performance going ahead. MSCI All Country Worldwide Index has generated a 15% annualised return over the last ten years. This index includes emerging and global market equities. U.S. has been a big driver of performance for the last ten years for this index. The point is that there are opportunities outside India as well.

What are the opportunities in other markets?

One can invest in the U.S., Europe, and other Asian markets. There are various funds available to gain exposure to such markets.

All markets don’t move up and down simultaneously. In other words, it is not necessary that when Indian markets have moved down, the other markets will also move down to the same extent at all points of time. Even the last year is a classic case. For the past 15 months, Indian equity markets haven’t done very well. If you look at other Asian markets, they have done well during the same period. Developed markets will typically have low co-relation to emerging markets.

How to find the right country to invest in and what should be the ideal allocation?

There are a few routes to invest in other markets. The first option is to remit money in foreign currency through the Liberalised Remittance Scheme which is permitted by the Reserve Bank of India, or, RBI. One can invest $ 2,50,000 per annum per Indian citizen through this route. The second option, which is easier to execute and manage than the first one, is to invest through international equity mutual funds. There are funds that take exposure to countries/regions like the U.S., Europe, Asia, Brazil and so on. And there are global equity funds which invest in a mix of all various countries. Your investment is done in rupee terms. You can do a systematic investment plan, or, SIP, systematic transfer plan, or, STP or invest lumpsum.

There are 40 odd mutual fund schemes in India that invest in various global markets. Multinational fund houses like Franklin Templeton, Invesco, Pramerica, HSBC, etc. collect money from Indian investors and invest in funds managed by their global peers. The Indian fund managers do not take the investment calls. Some domestic fund houses tie up with agencies that provide research to invest in global markets.

How do you decide which fund to invest in?

Don’t pick an emerging market country which is similar to India. Such emerging countries might exhibit the same kind of volatility as India. In technical terms, the co-relation might be high. You don’t get much diversification benefit by investing in a single emerging market country. Rather, you can choose a fund that invests in a basket of emerging markets like China, Brazil, Hong Kong, etc. One should also take exposure to developed markets like the U.S, Japan, and Europe. Don’t invest by looking at the past returns. Try to pick diversified funds that invest in multiple countries.

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