A diversified index may be the ideal way to enter US markets: Experts

Only later should you venture into narrower, more focused strategies, provided your risk appetite permits

Financial planners suggest investing in the United States (US) market first to retail investors who wish to diversify internationally. The US is the world’s largest equity market, accounting for about 59 per cent of global market capitalisation.

It is also home to the world’s top companies that are custodians of some of the most well-recognised brands. Indian investors taking the passive route have the option to invest in four US indices now: S&P 500, S&P 500 Top 50, NASDAQ-100, and NYSE Fang+.

Passive, the preferred route

Most experts advise investors to use passive funds for their US exposure. With this market becoming very efficient, active fund managers have found it hard to beat their benchmarks. Around 94 per cent of US large-cap active funds have failed to beat the S&P500 over the past 20 years, according to the 2020 year-end SPIVA (S&P Indices Versus Active) report.

“While in other markets the active versus passive debate may continue, in the US the consensus overwhelmingly favours passive funds on account of data such as this,” says Avinash Luthria, a Sebi-registered investment advisor and founder, Fiduciaries.

Diversified to narrow indices

Investors looking for highly diversified exposure across sectors and market caps should opt for a fund based on the S&P500 index. “This is a stable, less volatile option,” says Pratik Oswal, head of passive funds, Motilal Oswal Asset Management. This index offers investors exposure to mid- and small-cap stocks as well, alongside large-caps.

Another diversified index is the NASDAQ-100. (ICICI Prudential Mutual Fund’s new fund offer for an index fund based on this benchmark is on currently and will close on October 11) “It is oriented more towards growth industries, with higher concentration in technology (44 per cent) and communication services (29 per cent),” says Oswal.

The S&P 500 Top 50 index is a subset of the S&P 500. “It will give you exposure to the 50 top companies by market cap. It has a mega/large-cap orientation,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India. This is also a stable index that gives investors exposure to leaders across a range of sectors (it is not tech-heavy). 

Finally, there is the NYSE Fang+ Index, which gives equal weightage to 10, mostly internet/technology stocks. “This is a more focused strategy,” says Belapurkar.

Where should you invest?

US indices have outperformed the Nifty50 over the past 10 years. “Indian investors should, however, not enter US funds with the expectation that they will continue to outperform in the future as well. There could well be a reversion to mean. The primary reason for investing in the US market should be diversification,” says Luthria. The correlation between Indian and US equities is low at 0.16. 

Past performance should again not be the primary criterion when selecting a passive fund for your US exposure. Invest in a well-diversified index. Only after taking such exposure should you consider taking limited exposure to a more concentrated index, which could be more volatile, provided your risk appetite permits. 

Finally, these passive exposures may be available via the exchange-traded fund (ETF), fund of fund (FoF), or index format. “When investing in an ETF, watch out for liquidity-related issues, which could result in market price deviating from the net asset value (NAV). If the FoF is only 10-20 basis points costlier than the ETF, I would suggest opting for the latter to avoid liquidity-related issues,” says Belapurkar.

The index format is also desirable for retail investors as they can buy and sell at NAV from the fund house. No demat account is required for investing in an index fund, and investors can run a systematic investment plan (SIP) in them as well (all this holds true for FoFs also).