Maintain 15-20% allocation to international funds despite ongoing downturn

Remember that you need to diversify away from your home country, and hedge against the rupee's depreciation

Many retail investors have diversified their portfolios internationally over the past few years. Several international funds are witnessing a downturn. Motilal Oswal NASDAQ-100 Exchange Traded Fund (ETF), for instance, is down 24.6 per cent while its S&P 500 Index Fund is down 14.5 per cent year-to-date (YTD). Emerging market funds have been hit particularly hard: the PGIM India Emerging Markets Equity is down 33.7 per cent YTD.

Changing rate, liquidity environment

High inflation worldwide is the key concern. At 8.3 per cent in April, consumer inflation in the United States (US) was close to its 40-year high. The Russia-Ukraine war and China’s Covid-induced lockdown have exacerbated supply chain bottlenecks.

The Fede­ral Reserve (Fed) has begun to hike rates. From June 1, it will also begin to reduce the size of its balance sheet.

“While the market seems to have priced in gradual rate hik­es, it is jittery in case the pace of rate hikes or balance-sheet unwinding is faster than anticipated,” says Mahavir Kaswa, head of research, passive funds, Motilal Oswal Asset Management Company (AMC).

Turmoil in emerging markets

The massive pull-out of funds by foreign institutional investors (FIIs) from emerging markets has caused considerable volatility.

The market’s preference has swung from growth to value stocks. “Whenever the interest-rate regime changes, the secular or high-growth part of the market, and hence the funds that invest in them, tend to take a breather. Currently, investors are flocking more towards cyclical stocks, whereas the PGIM India Emerging Markets Equity invests more in long-term growth stocks,” says Abhishek Tiwari, chief business officer, PGIM India Mutual Fund.

During the good times, many flavour-of-the-month products were launched. “Several narrowly-focused funds have taken a beating,” says Avinash Luthria, a Sebi-registered investment advisor and founder, Fiduciaries.

US tech sector affected

Indian investors have exposure to the US tech sector. “Tech stocks had done very well during the pandemic. But with the lockdowns easing and consumers no longer homebound, their revenue growth has moderated,” says Kaswa.

The US tech space has older companies with established revenue models and profitability. There are also companies whose product or idea may be promising, but they are currently in the cash burn stage. “In this environment of rising interest rates, funding for some of these companies has come under question. Investors now want them to demonstrate their ability to generate profits,” says Rajeev Thakkar, chief investment officer, PPFAS Mutual Fund.  “Prices of both sets of companies have dipped. But while the more established companies have fallen about 25-30 per cent from their peaks, some of the loss-making ones have fallen more than 50 per cent,” adds Thakkar.

If goal is far away, stay put

Retail investors invest in international funds primarily for geographical diversification. “The need to diversify and not be concentrated entirely in the home market still exists,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisers.

While India may have been more resilient than many foreign markets over the past year, there is no guarantee this trend will continue. “Different markets perform better in different calendar years,” says Dhawan.

Indian investors also need exposure to foreign funds to counter the rupee’s tendency to depreciate against hard currencies, such as the US dollar, over the long term.

Dhawan suggests that Indian retail investors should continue with their long-term allocation of around 20 per cent to international funds.

If an investor’s goal is, say,  six months away, she may pull money out of foreign funds. “But if the goal is several years away, stay calm and remain invested,” says Kaswa.

With valuations near or below long-term averages, in­ve­s­tors may even add to their exposure. “After the recent fall, valuations have become attractive, making the fund an attractive buy,” says Tiwari of PGIM India.   

The current downturn in the US tech sector should not cause undue pessimism. “Such downturns are not unusual. If you look at the 15-20-year history of stocks like Apple, Microsoft, or Amazon, which have created immense long-term wealth, they have fallen by 30-40 per cent in several calendar years,” says Thakkar.

Avoid funds with narrow mandate

If you are new to international investing, go for a passive option to avoid fund manager risk. “Stick to the broadest possible indexes, such as funds ba­sed on the S&P 500 index and the US Total Stock Market index,” says Luthria.

A fund that gives broad exposure to the developed world, such as the HDFC Developed World Indexes Fund of Funds may also be purchased (subject to availability).

Investors may take some exposure to an emerging market fund in their asset-allocated portfolio. “Over the past 20 years, on a nominal growth basis, emerging markets have grown faster than developed markets, and also contributed a higher percentage to world GDP growth. Also, unique and scalable businesses not available in the home market add to the diversification benefit,” says Tiwari.

Things to watch out for

Due to the prevailing restrictions on investing in foreign funds, many ETFs are trading at a premium to the net asset value (NAV). “Make sure the market price and the NAV are reasonably close to each other,” says Dhawan.

Finally, according to Luthria, investors need to be mindful of cost, especially when investing in the regular plan of an active fund. “Some fund houses disclose the total fee, while some disclose only the India fee, and reveal the international fund’s fee separately in a footnote.”