Diversify portfolio by investing offshore
Low correlation means you can reduce volatility by taking exposure in other markets
When speaking on our Apple or Samsung smartphone, or using web sites like Google and Facebook, most of us have at one point or the other wondered if we can own the stocks of these marquee companies.
High net worth individuals in particular need to invest in off-shore markets to create a well-diversified portfolio.
Low correlation: Portfolios of most Indian investors are not adequately diversified geographically. What makes a global allocation essential for equity investors is the low correlation between different markets. The returns analysis of major indices over the past nine years demonstrates that there is limited correlation between equity markets ( see table). In calendar year 2018, the Nifty had given a positive return of 6 per cent, whereas returns from all the other major indices were negative. In calendar year 2013, the situation was quite different. That year the US S&P 500 Index had given a blockbuster return of 30 per cent, while the Nifty had given much lower gains of 9 per cent. By diversifying into offshore markets, Indian investors can make the returns from their portfolios less volatile. In the years when the Indian market does not do well, foreign markets can provide downside protection to the portfolio.
Massive opportunities: Apart from the issue of returns, one also needs to consider investing internationally because of the sheer size of the opportunity available. Currently, India’s equity market capitalisation is barely 3 per cent of the world equity market and it ranks seventh in size. The US market, on the other hand, accounts for 38.7 per cent of global equity market capitalisation. Foraying abroad will give Indian investors the opportunity to invest in the stocks of a large number of multinational giants. Many global names such as Apple, Amazon, Alphabet, Alibaba, Facebook, Netflix, Samsung, Walmart and others resonate with Indian investors.
Currency hedge: Investing in offshore products is also beneficial for individuals and families that expect large expenditures overseas in the future by providing a currency hedge. As we have observed in the past, currency depreciation is never linear. The currency stays stable for a while and then depreciates sharply. Families that plan to send their children overseas for education, or those that plan to buy a house abroad, need to safeguard their investments against currency depreciation. Owing to the steep currency depreciation recently, many families were forced to shell out more than they had anticipated. One way families can safeguard themselves against this risk is by investing at least a part of their portfolio in offshore products. This will limit the impact of currency depreciation.
Over the past nine years, the rupee has depreciated from ~46.53 per dollar at the start of 2010 to ~69.77 per dollar at the end of 2018. While the absolute depreciation is approximately 50 per cent, average per year depreciation is approximately 5.7 per cent. Thus, currency depreciation is a very important reason why one needs to include offshore products in the portfolio.
Next, let us turn to the options available to Indian investors for investing in overseas markets. Two routes are available: the first is to invest in rupee-denominated offshore mutual funds available in India, and the second is to avail of the Liberalised Remittance Scheme (LRS) and invest directly in overseas markets.
International funds: Offshore funds are mutual fund schemes that invest in global equity markets. Many of these funds are country or region specific, while others are thematic or sector specific. Offshore funds may invest either directly or indirectly in global equity markets.
One category of offshore mutual funds invests directly in global equity markets. These funds are managed by an active fund management team domestically. Then there are the feeder funds, which pool funds from domestic investors and then invest the corpus in either a parent company’s offshore fund or in a basket of offshore mutual funds (in which case they are referred to as fund of funds). These funds are actively managed by an offshore fund management team. The third category consists of global funds, which have the mandate to invest in both domestic and international markets. These funds focus prim arily on the domestic markets and provide limited exposure to foreign equities.
LRS route: High and ultra high net worth investors can also consider engaging with an overseas wealth advisor. They can avail of the Liberalised Remittance Scheme (LRS) to remit funds abroad and invest in overseas capital markets directly. According to RBI guidelines, individuals including minors can remit up to $250,000 a year. The remittances can be made in any freely convertible foreign currency. There are also no restrictions on the frequency of remittances under LRS.
Finally, investors who have invested adequately in various segments of the Indian stock market should consider allocating 10-20 per cent of their equity portfolio to offshore capital markets.