Returns from US funds may be muted amid US-China trade tensions

After rallying for 11 years, valuations seem to be on the higher side; patience is key for new investors

US-focused funds available in India have, on an average, run up 17.78 per cent over the past year. Over the past six months, they have risen 10.38 per cent. Their long-term performance has also been very attractive.

The primary reason for the upsurge is that earnings growth for S&P 500 stocks has delivered a surprise. Instead of the -2 to -8 per cent that analysts expected, returns came in the 0-2 per cent range. Also, due to US-China trade tensions, many US-based investors pulled money out of emerging markets and invested it in their home market. Three rate cuts between July and October to combat the slowing economy also provided support.

There was fear that the trade war with China would lead to the economy entering a recession. “But the latest jobs data has been positive. The yield difference between the two-year bond and the 10-year bond has widened again. These data points indicate that the US economy is stabilising,” says Gopal Agrawal, head-macro strategy, DSP Investment Managers. All these factors have kept the markets buoyant.

The US market has enjoyed an 11-year long rally. The S&P 500 had fallen to the 700-level during the 2008 downturn and has since climbed to the current 3,140-level, aided by a long phase of economic expansion. Technology and lifestyle-oriented stocks have done particularly well in this period.

After such a stupendous run, investors need to tone down future expectations. The S&P 500 index is trading at a price-to-earnings ratio of 18x current-year earnings. “Valuations have turned expensive. That is the biggest risk in the US market now,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India.  

Until recently, one supportive argument in favour of the US market was that the dividend yield of the S&P 500 basket was higher than that of the 10-year government bond. “Currently the dividend yield of the S&P 500 basket is 1.9 per cent. The yield on the 10-year bond is now approaching this level. Earnings growth expectations are also muted,” says Agarwal.

Most investors take exposure to US funds to diversify their portfolios geographically. “So long as the allocation to all global funds, including US funds, is in the range of 10-20 per cent of the equity portfolio, investors need not worry. Only if it exceeds this level should they book profits,” says Belapurkar.

New investors should not enter US funds chasing past returns. Such returns may not get replicated in the near future. Moreover, Indian investors tend to invest in global funds only when the domestic market is doing poorly. As soon as it starts running up, they forget about geographical diversification. “Enter these funds with an asset allocation mindset and have a horizon of more than seven years,” says Belapurkar.

When selecting a fund-of-fund, look up the track record of the underlying fund. Take into consideration the expense ratio of the feeder fund and the mother fund. “At present, when the US market is doing well, expense ratios may not matter. But they will matter a great deal once returns normalise,” says Avinash Luthria, a Securities and Exchange Board of India-registered investment advisor and founder, Fiduciaries.