Investing in international funds ensure portfolio diversification, reducing risk by not being solely reliant on the performance of the Indian market. Additionally, international funds open up investment opportunities in new markets, potentially aiding wealth creation.
Returns from international funds are rising because of the rally in those having allocation towards the US economy, especially US tech. As international stocks such as those in the S&P 500 index are trading close to or below the average medium-term P/E, there could be an opportunity for investors to buy select high-quality stocks at reasonable valuations, especially on the back of strong fundamentals. Moreover, for new-age sectors like AI, the representation from listed firms in India is less. Investors can use international funds to diversify investments into such domains.
“From a long-term portfolio standpoint, global diversification is important as it leads to lower equity portfolio volatility and reduced country-specific risk. It also offers exposure to notable global companies and acts as a decent hedge against currency risk,” says Shrinath ML, senior research analyst, FundsIndia.
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Diversification benefits
While select international funds continue to hold significant promise, investors must understand the risks involved and the near-term volatility in global stocks. “One must be selective with choice of fund, acknowledge risks involved and appreciate that the near term may be a bumpy ride considering the global backdrop,” says Nirav Karkera, head of research, Fisdom.
There may be sectors in which a country excels, and investors can reap the benefits if investment opportunities arise. Harish Menon, co-founder and head of Investments and Product Research, House of Alpha, says if a foreign market offers a unique investment opportunity with a superior risk-reward profile compared to local options, international diversification is a logical choice. “However, haphazardly adding a few international funds may not necessarily optimise one’s portfolio. Careful analysis is required to make informed investment decisions,” he says.
Gains from rupee depreciation
In the last five years, the S&P 500 has given returns of 9% CAGR. During the same period, the USD-INR exchange rate has increased by 5% CAGR, indicating a depreciation of the rupee against the dollar. So, if an investor had put money into a dollar-denominated fund tracking the S&P 500 Index, the return in rupees would be the return of the fund plus the gain from the exchange rate movement. The S&P 500 Index would have returned 14% on a CAGR basis in rupee terms indicating how investors can enhance their returns through dollar-denominated investments when the rupee depreciates against the dollar.
“Investors must note that this can work the other way. If the rupee were to appreciate against the dollar, this could diminish the rupee returns of the investment to the extent. As such, currency risk is a significant factor to consider when investing in dollar-denominated or any other foreign currency denominated funds,” says Karkera.
Beyond US markets
It is beneficial not to just restrict exposure to the US market despite its size and liquidity. Sonam Srivastava, founder, Wright Research, says other markets, including China and Europe, present attractive investment opportunities. “Diversification across various countries can reduce risk, as market performances are not always correlated. Investing outside the US can offer unique opportunities unavailable in the Indian market,” says Srivastava.
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While US listed companies have an edge in sectors such as technology, there are sectors such as manufacturing where an investor can find better opportunities through diversification across other geographies. Divam Sharma, founder, Green Portfolio, says some developed economies including the US have a high probability of recession in the coming calendar year. “However, markets such as Brazil, Vietnam, Mexico are providing opportunities to diversify at comfortable valuations and strong market and business fundamentals,” he says.
Invest through passive funds
Building an international portfolio through passive funds can be advantageous as they are cheaper than active funds and also more tax-efficient. Moreover, they are easier to manage due to their nature, which doesn’t require frequent trading. “US markets are well-developed and there is increasing evidence that a large proportion of active fund managers have not been able to beat their passive indices. We prefer passive strategies such as NASDAQ 100 and S&P 500 to play the US market,” says FundsIndia’s Shrinath ML.
OVERSEAS BETS
* Foreign stocks such as those in the S&P 500 index are trading close to or below the average medium-term P/E
* Build an international portfolio through passive funds as they are cheaper & more tax-efficient
* Look beyond US to markets such as China and Europe