Higher fund flows into India, other EMs likely to boost asset prices

Stick to asset allocation, avoid wholesale portfolio changes

Investors are closely watching the dollar index (DXY), which is approaching the critical level of 100. It was at the 102.2 level on January 4. After peaking at 114.1 in September 2022, the DXY briefly dropped below 100 in July 2023 and rose to 107 in October. It has weakened again in recent months.

“The probability of interest rates declining has provided a fillip to non-dollar currencies and caused the dollar index to fall intermittently over the past three months,” says Joseph Thomas, head of research, Emkay Wealth Management.

Significance

The DXY measures the US dollar’s strength against a basket of seven major currencies. A stronger dollar results in a higher DXY, and vice versa. In uncertain times, investors gravitate towards the safety of the US dollar, boosting the DXY. Even during interest rate hikes in the US, the DXY typically rises as capital flows back into the US, increasing the demand for the greenback.

“A contracting dollar index could positively impact various asset classes, including stocks and bonds in both emerging and developed markets, as well as gold,” says Vishal Dhawan, founder and chief executive officer, Plan Ahead Wealth Advisors.

Emerging markets gain

A declining DXY is likely to lead to fund flows into emerging markets like India, inflating asset prices. “A weakening dollar attracts FII flows into emerging markets due to the opportunities for higher returns. This was evident recently. The DXY fell 5 to 6 per cent over the past two months. FIIs turned net buyers to the tune of Rs 35,800 crore over November-December 2023 after being net sellers over the previous three months,” says Jayesh Faria, director, regional head west, Motilal Oswal Private Wealth, referring to foreign institutional investors.

Dhawan notes that the Nifty 50 and other emerging markets typically exhibit an inverse relationship with the DXY.

Impact on debt funds

Investors may consider allocating money to long-duration government securities (G-Secs). Thomas says the inclusion of local government bonds in global indexes (the JP Morgan global bond index for emerging markets) may also trigger a lot of flows into them, so one may enter them with a one- to two-year horizon. He also suggests investing in a carefully selected portfolio of corporate bond funds.

Dhawan anticipates rate cuts by the Reserve Bank of India in the second half of 2024 but at a slower pace than the US Federal Reserve. “Investors may add duration to their portfolios, in addition to short-term funds. The higher duration allocation can be 30 to 40 per cent of the fixed-income portfolio,” he says.

Investors with dollar-denominated financial goals may also look at Indian debt funds investing in short- to medium-term US treasuries, which will gain from rate cuts in the US. 

Gold’s prospects brighten

Gold is valued in dollars in the international market. Its price moves up when the dollar weakens. Other precious metals like silver also tend to rally during a period of rate cuts.

“Both gold and silver are likely to benefit from a decline in the US dollar. However, one should not allocate more than 5 to 10 per cent of the portfolio to these precious metals,” says Thomas.

Invest in gold and silver through Sovereign Gold Bonds and exchange-traded funds (ETFs).

Parents to benefit

Parents with dollar-denominated expenses, such as funding children’s education abroad, could benefit from a weaker dollar. “If the DXY declines, the rupee will appreciate, resulting in reduced expenditure on dollar-denominated goals. Parents or individuals who have invested in dollar-denominated assets like international equities for their children’s education would benefit from equities doing well as the dollar weakens,” says Dhawan.
 

Stick to basics

While investing in times of ‘risk-on’ sentiment (that may occur in the future), investors should avoid chasing fads. They should decide their asset allocation based on their financial goals. While sticking to a diversified portfolio, they may take small tactical calls to benefit from a weakening DXY.