Your Money: Diversify market and currency risk with US funds

Investors with adequate exposure to Indian equities should invest in US funds to avoid the risk of being exposed only to the Indian market

While the Nifty is down more than four per cent since November 8, primarily due to the demonetisation effect, the US benchmark S&P 500 is up above five per cent since then. US-focused funds available in India are up about 0.04-4 per cent over the past month. Over the past year, these funds have given an average return of 11.42 per cent, compared to the Nifty's 4.86 per cent, underlining the need for Indian investors to diversify a part of their portfolio into US funds for those times when Indian equities are not doing too well.

Prior to the US Presidential election, the popular view was that the world's largest equity market would tank if Donald Trump was elected, since he was perceived to be an unknown entity (in policy terms, compared to Hillary Clinton, who represented continuity). Instead, the markets have reacted positively. "The US markets have done well because there is a feeling that Trump will be good for business. His promise to enhance infrastructure spending has led to stocks in related sectors doing very well," says Sunil Singhania, chief investment officer-equity investments, Reliance Mutual Fund, which runs Reliance US Equity Opportunities Fund.

There has also been a rotation of funds away from bond markets (which have sold off in the past few weeks) into equities. "Even financial stocks have done well as the transition team has pledged to repeal the Dodd-Frank Act of 2010, which imposes restrictions on the activities of Wall Street Banks," says Kunal Bajaj, founder and chief executive officer, Clearfunds.com, a Sebi-registered online investment advisor.

The good run these funds have enjoyed in the past may not end just because the US Federal Reserve is thinking of raising interest rates in 2017. In the past, the Fed has been notoriously slow in raising rates for fear of pricking a rally in equities. This is likely to hold true in the future also.

The longer-term reason why Indian investors should have exposure to US funds is to diversify their portfolio. "The US market has a low correlation with the Indian market," says Singhania. Indian investors, especially high net worth individuals, who have taken adequate exposure to Indian equities, should invest about 10 per cent of their equity corpus in US funds (going up to 20 per cent).    

Why diversify into US-focused funds

These funds have been doing well since Donald's Trump's election

They have also outperformed Indian equities over the past one year

Since India belongs to the emerging-market category and the US belongs to the developed-market category, the correlation between them is low, which can help Indian investors diversify their portfolio

Investing in US funds also provides protection against the risk of rupee depreciation

Investing in the world's largest equity market also provides Indian investors exposure to global firms, and to sectors not represented on Indian bourses

Investing in US funds can also help Indian investors counter the effect of the rupee's depreciation against the dollar over the long term. "If you have financial goals that are dollar denominated, such as your child's college education or foreign trips, it makes sense to invest a part of your corpus in US-focused funds to guard against the rupee's depreciation," says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors. The rupee's depreciation provides a kicker to the returns of these funds.

Many of the stocks that these funds invest in are of US-based multinationals. Thus, investing in these funds is not just a bet on the US market but on multiple markets throughout the world. These funds can also give Indian investors access to stocks not found on the Indian bourses, such as large entertainment players (Walt Disney), hardware innovators (like Apple), investment companies (Berkshire), card companies (Visa), social media players (Facebook, Linkedin), and so on.    

These funds do carry the risk that if the US equity markets underperform, so will these funds.

When selecting a fund, besides looking up the track record, investors should also try to keep costs low. Bajaj points out that unlike India, where actively managed funds outperform, in developed markets index-based strategies tend to do better. Investing in direct plans of these funds can also help investors lower their costs.

Finally, have an investment horizon of at least three years. All international funds are treated at par with debt funds, so you will get to enjoy the more beneficial tax treatment (20 per cent with indexation benefit) only after three years.