Stay in US funds if horizon exceeds seven years, exposure less than 20%

If you are worried about a US-only exposure following the downgrade of US government debt, go for a globally diversified fund

Moody’s Investors Service downgraded the United States (US) government’s credit rating from AAA to AA1 on May 16, 2025. This has sparked concern among Indian retail investors who have diversified globally, with many questioning whether to maintain, reduce, or exit their US fund holdings.

Why the downgrade happened

The downgrade stems from the US’s widening fiscal deficit and elevated debt-to-GDP ratio. “The high level of debt-to-GDP ratio could make it difficult for the US to service its debt,” says Pratik Oswal, chief of passive business, Motilal Oswal Asset Management Company (AMC).

 

Moody’s was the last of the three major rating agencies to lower the US’s rating, following the S&P (2011) and Fitch (2023).

Fixed income market impacted

The fixed-income market reacted to the downgrade, with the 30-year Treasury yield rising above 5 per cent as investors demanded higher returns for perceived risk.

 

Longer-term risks include rising borrowing costs and inflation. “If the cost of borrowing for the government goes up, then typically the cost for companies also rises,” pointed out Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

 

The reaction in the equity markets was more muted. Experts say the US market has large corporates, which are resilient, have high pricing power, and derive their revenues not just from the US market but globally.

Limited impact likely on dollar

Central banks have for some time been hedging their risks by diversifying their reserves into other currencies and gold. “The debate around de-dollarisation will get more attention due to this downgrade,” says Dhawan.

 

Experts do not expect the downgrade to have a material impact on the dollar’s strength. “Most of the forex reserves across the world is still held in the dollar,” he says.

 

It may, however, slightly weaken the dollar, which would reduce rupee-adjusted returns for Indian investors. “Being downgraded one notch from AAA could have some impact, but it will not be substantial,” says Kaustubh Belapurkar, director–manager (research), Morningstar Investment Research India.

Innovation hub

The US remains a hub for innovation, especially in artificial intelligence (AI). “If you want exposure to some of the leading AI companies, then the US market must be a part of your portfolio,” says Oswal. The labour market in the US remains robust.

 

A bilateral trade agreement with the United Kingdom, a 90-day pause vis-à-vis China, and advanced negotiations with India have eased tensions. “The US appears to be softening its stance on tariffs,” says Dhawan. 

Policy, valuations, and earnings risks

Policy decisions and ongoing wars in several global hotspots pose risks. “Trade wars and geopolitical tensions could have a short-term impact on these funds,” says Oswal.

 

Belapurkar points out that the imposition of reciprocal tariffs could stoke inflation. Dhawan adds that a global slowdown resulting from tariffs could affect US companies.

 

A weaker dollar could reduce returns for Indian investors. “If the US dollar depreciates against the rupee, that would erode the returns of these funds,” says Dhawan.

 

Higher bond yields may also cause diversion of capital from equities, affecting the latter asset class negatively.

Above-average valuations

The S&P 500 currently trades above historical valuation averages. “The top 7–10 mega-cap companies are pricing in the high opportunity in AI,” says Oswal.

 

Sustaining the recent market recovery will depend on earnings. “Only with double-digit growth can US equities sustain the kind of valuations they have currently,” adds Dhawan.

Entry strategy for new investors

Investors with a long horizon may consider US funds for diversification. “The US market has a low correlation with the Indian market,” says Oswal.

 

He cites innovation leadership and long-term rupee depreciation as other reasons. “The dollar has appreciated 3–5 per cent against the rupee over the past 15–20 years,” he says.

 

Belapurkar highlights Indian investors’ home bias as a key reason why they need to be globally diversified. He advises that rather than worry about valuations and wait for a correction, investors should begin investing systematically.

 

Dhawan suggests global funds for broader diversification. “This could diversify their risks from a US-only exposure in their portfolios,” he says,

What existing investors should do

Oswal recommends 10–20 per cent equity exposure outside India. Investors should check their current US allocation against their targets and also factor in their dollar-linked goals such as education and travel. “Investors with up to 20 per cent exposure should do nothing,” says Dhawan. If an investor’s exposure has gone beyond this level, they may consider rebalancing.

 

Given rich valuations, investors should take the SIP route in US equities and enter with a seven-year plus holding period.