Investors should rebalance exposure to US-focused funds; don't exit

Profits booked in these funds should be deployed in a diversified EM fund

US-focused funds have rewarded investors well with an average return of 31.2 per cent over the past year and 15 per cent (compound annualised) over seven years. Such a stellar performance has given rise to many questions in the minds of new and existing investors. 

Why invest in the US market?

Investing in US equities provides geographical diversification. The correlation between Indian indices like the Nifty50 total returns index (TRI) and Nifty 500 TRI with the Nasdaq 100 TRI is just about 0.2.    

The US is the most developed market in the world with very high-quality companies. Many of them are global, and not just American, brands that are at the forefront of technology in their areas. Indian investors could get exposure to the likes of Alphabet, Amazon, Tesla, Netflix, Zoom, Moderna, etc.

“Many of these companies were not only unaffected by the pandemic, but even gained market share globally during it,” says Harsha Upadhyaya, chief investment officer-equity, Kotak Asset Management Company (AMC). The fund house’s ongoing new fund offer for Kotak Nasdaq 100 Fund of Fund will close on January 25.    

Investing in the US market also provides Indian investors a hedge against the rupee’s long-term tendency to depreciate against the dollar.  

Will the bull run continue?

The US market has been trending upward since early 2009, with intermittent corrections.

“US companies have become more capital efficient. Many have been buying back their own shares. They have also been at the forefront in incorporating technology,” says Upadhyaya.

The outlook remains strong. “Economic growth is expected to bounce back in 2021 if the novel coronavirus is contained. Also, the US Federal Reserve (US Fed) has promised to keep the liquidity tap open, which could boost equities,” says Arnav Pandya, founder, Moneyeduschool.

What are the risks?

The key risk arises from valuations, which are above long-term averages. Liquidity-driven rerating has happened. Its withdrawal could cause volatility.

“If US inflation goes beyond the 2-per cent level, the US Fed could be forced to normalise its monetary policy. That could result in a sharp correction in its equity market,” says Arun Kumar, head of research, FundsIndia.com.  

Should you enter now?

Making a lump-sum investment or investing for the short term would be risky at present, according to Pandya. Kumar says anyone investing now should have at least a seven-year horizon. Investments should be staggered.

With a large percentage of active fund managers in developed markets failing to beat their benchmarks, experts say investing in a passive fund would be a safer bet.

“Go with an S&P 500-based index fund, which is diversified. For more concentrated exposure towards tech giants, you may consider the Nasdaq index,” says Kumar.

Exposure between the two indices could be split, based on the investor’s risk appetite.

What should existing investors do?

They would have seen their exposure to US equities rise. They should not exit entirely, since the bull market could continue, but should definitely rebalance. Most investors could have a 20 per cent exposure to foreign equities, of which 10-12 per cent could be to US equities.

Profit booked in US equities could be put into an emerging market (EM) fund. The outlook is positive for them.

“The dollar has been weakening. As the vaccination progresses and we overcome the pandemic, global growth could recover. EM valuations are also reasonable currently,” says Kumar.

In case of an EM fund, Kumar suggests going for an actively managed, diversified EM fund (not a country-focused one). Go with a reputed AMC where the mother fund is large and has a strong track record.