Diversifying global investments beyond the US can reduce portfolio risk

A diversified fund that captures growth in other developed markets should be your next stop

Indian retail investors are increasingly accepting the need to diversify internationally to protect their portfolios from the risk of a downturn in the Indian equity market. Most have begun their international foray by investing in the US market, the world’s largest equity market, which accounts for around 56 per cent of global market cap. However, after a multi-year bull run in the US market, investors are looking to diversify into other markets. Mutual fund houses, too, have responded by coming out with non-US market offerings.

Recent non-US offerings

One such offering is the Motilal Oswal MSCI EAFE Top 100 Index Fund (MET100). The scheme will track the MSCI EAFE (Europe, Australasia and Far East) Top 100 index, which invests in the top 100 stocks by market capitalisation in the parent MSCI EAFE Index. This index covers most of the key developed markets barring the US.

Other non-US offerings that have been launched recently (or will be launched shortly) are Mirae Asset Hang Seng Tech ETF and FoF and Nippon India Taiwan Equity Fund.

According to Pratik Oswal, head of passive funds, Motilal Oswal Asset Management Company (AMC), “For investors, the best way to invest internationally is to have a diversified approach, with exposure to multiple geographies. By focusing only on the US, investors are missing out on the opportunities in other key markets.” The MSCI EAFE index covers the top 10 developed countries outside the US, which account for roughly 30 per cent of the world’s market cap.

Nippon India Taiwan Equity Fund will provide Indian investors exposure to Taiwan’s semi-conductor industry, which accounts for more than half of the world’s share in semi-conductor/integrated circuit manufacturing. “Taiwan is the second largest country by weight (14.7 per cent) in MSCI EM index after China,” says Sundeep Sikka, executive director and chief executive officer, Nippon India Mutual Fund. India ranks fourth in the index (12.2 per cent).

    

Why look beyond the US

Though the US accounts for the biggest chunk of global market capitalisation, it would be wise to look beyond it. Diversifying into other markets will reduce the risk of high valuations in the US market, country-specific risk, and currency risk.

“Both the US and the Indian market indices have run up a lot over the past year. By investing in funds such as the Motilal Oswal MSCI EAFE Top 100 Index, investors could benefit from the contrarian view that the selected geographies may perform better in the coming months,” says Arvind A Rao, certified financial planner and founder, Arvind Rao & Associates.

Diversifying across international markets can reduce portfolio risk. Says Arun Kumar, head of research, mutual funds, Fundsindia.com: “Different markets tend to do well in different periods of time. While the US market has done well over the past 12 years, the EAFE index had outperformed in the seven years (2001-07) prior to that. Balancing exposure across both can be a good way to play the developed markets without trying to predict which market will do well.”

Key non-US markets such as Europe, UK, Japan and Taiwan house many multinationals that are innovation leaders and offer goods and services to the population across the world. Indian investors can benefit from the long-term prospects of these markets. “These markets are home to many competitive and innovative companies. Also, most of them have relatively stable financial markets and have political stability. Investors can hope to generate reasonable long-term returns by investing in these non-US markets,” says Kumar.

US should remain the core holding

When diversifying abroad, Indian investors should first take exposure to developed markets (for diversification, since India belongs to the emerging market basket). The US can serve as the core component of the international portfolio. “These new funds should not be considered as alternatives to US market exposure but should complement them,” says Rao. Investors may be aiming for, say, 20 per cent allocation in their equity portfolio to international funds. US focused funds can constitute 10-15 per cent of this allocation, while 5-10 per cent allocation can be given to a diversified, non-US, developed market focused fund.

As investors get more comfortable, they may expand their international exposure and foray into a diversified emerging market fund. Exposure to country-specific and thematic funds should be limited unless the investor is knowledgeable about that country or theme.