Shift to a diversified passive fund to survive fickle US market: Analysts

Besides growth-oriented active fund, add value-oriented fund to your portfolio

The Nasdaq-100 and the S&P 500 Index of the US have corrected 13.1 per cent and 6.9 per cent, respectively, from their 52-week peaks. Indian investors, who in the past few years have begun investing in US-focused funds, need to brace for higher volatility.

Rate hike fears

Inflation is the key factor roiling the US market.

“Investors now expect central banks across the world to increase interest rates at a quicker pace than was envisaged earlier. Bond yields are hardening. When the cost of capital rises, equity valuations tend to come down,” says Rajeev Thakkar, chief investment officer, PPFAS Mutual Fund (MF). Valuations of many mid- and small-cap compa­nies in the US technology (tech) space, some with non-existent earnings, had run up ahead of fundamentals. “Many such companies are witnessing a correction now,” says Pratik Oswal, head–passive funds, Motilal Oswal Asset Management Company.

Nasdaq has taken a bigger hit

The Nasdaq-100 Index has fallen more than the S&P 500 Index. 

“The Nasdaq-100 has more high-growth stocks, compared to the S&P 500. As interest rates rise, and with it the discounting rate for valuing companies, the impact is bigger on high-growth businesses,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors. The Nasdaq-100 has higher exposure to growth-oriented sectors like tech, consumer services, and health care. “The S&P 500 Index has exposure to value-oriented sectors also, such as energy, utilities, real estate, and so on. Over the past year, value-oriented sectors have performed better,” says Oswal.  

Moderate return expectations

The US market, which has been in a prolonged bull run since 2009, may take a breather. “However, as the economy grows and corporate profits increase, stock prices will rise over time,” says Thakkar. 

The near-unidirectional rise in US equities may give way to higher volatility in the near term.

“The high returns investors have enjoyed over the past several years may decline as US equities adjust to a lower liquidity environment and higher interest rates,” says Dhawan.

Stay geographically diversified  

Despite the expected volatility, investors must maintain exposure to US funds to reduce dependence on their home market.

“A 15-20 per cent allocation to foreign equities reduces portfolio risk considerably,” says Oswal. Besides, he says, a bet on US equities amo­unts to a bet on global growth, since many of these companies are multinationals. 

Most investors would have entered these equity funds with a 7-10-year horizon. They should stick to it. Remember that equities are intrinsically volatile.

“In 2008, the Nifty50 Total Returns Index had declined 59 per cent. That is the kind of volatility you need to be prepared for,” says Avinash Luthria, a Securities and Exchange Board of India-registered investment advisor and founder, Fiduciaries. He adds that investors who feel they have overestimated their tolerance for volatility should reduce their equity allocation (including to foreign equities).

Passive funds based on the Nasdaq-100 Index were the first to become available; so many investors took exposure to them.

“The Nasdaq-100 is a more volatile index than the S&P 500. Your primary holding should be a fund based on a more diversified index like the S&P 500,” says Luthria.

Navi MF’s Navi US Total Stock Market Fund of Fund, whose new fund offer is on at present, is another diversified option that may be considered. Investors who desire broader developed-market exposure may consider the HDFC Developed World Indexes Fund of Funds.

Those who have invested in growth-oriented active US funds may add a value-oriented fund to the mix. Due to the ongoing limit breach issue, investors may have to wait for some time before they are able to make these changes. Also consider the tax impact: international funds are treated on a par with debt funds and you need to exit after three years to enjoy the more favourable tax treatment on long-term capital gains.