By Nirav Karkera
Investing is primarily about optimising risks and generating returns. Successful investors go through a lifetime simply balancing the two. Many seek opportunities on both fronts, even beyond Indian boundaries.
While most advocate the case for international investing basis the basic premise of diversification, there are some who truly believe that unique opportunities available overseas are more rewarding. But like with most things in life, the truth lies somewhere in the middle.
However, if India is indeed among the fastest-growing economies why bother investing elsewhere? If the U.S. is vulnerable to the risk of recession, why invest in such an economy at all? In a globalised world where economies are connected, does international investing even offer true diversification? If there’s any merit to investing in US equities, what is the best way to go about it?
The next set of elaboration aims to offer perspectives to help the average Indian investor make better-informed decisions around investing in international equities, specifically ones listed in the U.S.
Why go beyond India at all
A robust economic growth story is in the works for India. With all critical engines of growth picking pace, corporate earnings and equities representing the same are expected to undergo a structural expansionary cycle imminently.
This does make a solid case for broad-based performance. However, even the most structural growth story can’t fully insulate against inherent risks like geopolitical risks, currency risk, regulatory risks and similar risks incidental to single-geography equities.
An effective way to mitigate such risk is to diversify beyond the said geography. Now, another thing about broad-based performance is the limited range of performance at a security level when benefits of economic tailwinds spread across an expansive and diverse set of segments.
While such a phenomenon grants absolute performance, relative outperformance is generated through select high-growth bets. Such high-growth bets are not limited to within geographic boundaries.
If overseas, why America?
For beginners, equity markets in the U.S. are the most developed in terms of governance, breadth, depth and liquidity. The markets also rank the highest in terms of tracking and volume participation, making it among the closest markets to represent an efficient market.
At the same time, many of the world’s largest corporate brands are listed on exchanges domiciled in the U.S. The greenback maintains its reputation as a dominant currency which adds to the sheen.
A combination of U.S. markets offering a conducive proposition and the absence of a challenger developed market deems U.S. as the preferred destination for overseas investing.
Is it wiser to pick a stock or an index?
Drawing upon the previous premise that U.S. markets are perhaps the closest representation of an efficient market, one can conclude that there is very limited scope to generate wealth consistently basis information or price arbitrage.
While the broader indices feature a variety of highly promising plays, if one lacks access to requisite know-how or resources to successfully invest in stocks directly, an index is a perfectly reasonable alternative.
In fact, there have been a number of credible studies highlighting the effectiveness of passive investing through indices versus active stock selection, especially in efficient markets.
How to choose the correct index?
While there are many indices, the S&P 500 and NASDAQ 100 are not just bellwether indices but have also demonstrated relative consistency, lesser volatility and better risk-adjusted performance through multiple market cycles. For someone simply seeking exposure to the U.S. economy and the largest corporates in the nation, these indices offer a strong value proposition. For ones inclined towards a technology-heavy orientation, an overweight on the NASDAQ index could prove beneficial.
Best way for Indians to invest in US markets
Regulations and taxation policies around foreign remittance makes the direct investing proposition accessible and feasible to a limited clutch of high net-worth individuals and corporates. However, Indian mutual funds investing into select indices or Exchange Traded Funds offer an effective and efficient route for investors seeking to invest in US indices. In line with regulatory instructions, many such funds may restrict inflows but often there will be alternative funds offering a similar play.
Why global diversification
A portfolio diversified across the two geographies ensure that the portfolio is relatively insulated against risks emanating in one market when the other remains non-correlated. However, there may be global black swans like the pandemic that could still erode portfolio value significantly.
It is quite possible that the portfolio may hit a patch in time when equities in both markets slip into a downtrend probably due to headwinds unique to each market.
While there are quite a number of possibilities to illustrate the risk involved, the bottom-line would be that such a diversification serves limited needs and the decision to diversify must not rest on the premise of risk management alone.
Does this make sense for every investor?
Any long-term equity investor must seek to diversify beyond Indian equities, unless there is a domestic-focused strategy that the investor has conviction in. This also makes sense for investors seeking to achieve a dollar-denominated financial goal.
Simply investing in US stocks may not be the most effective risk management strategy nor will it be a standalone outperformance driver. For Indian investors, US investing must be a part of a larger portfolio strategy where it seeks to optimise on both fronts – risk and returns. Indians must seek to invest primarily in domestic equities but must be open to diversifying in global opportunities.
(Author is Head of Research at Fisdom)