The options for investors are more nowadays with the spread of technology and fund innovation.
Market levels being where they are, if you are feeling iffy, then the pragmatic approach apart from investing for the long term is to diversify. Diversification is across asset categories, i.e. equity, debt, gold, etc. Apart from that, it can be across geographies, as the risk profile of markets are different, correlation between two markets is low and that effectively diversifies your risks. The options for investors are more nowadays, with the spread of technology and fund innovation. In the context of spreading your investment portfolio, we will discuss about the US market, as it is the global leader in market cap. For a perspective, India being the growth economy, a majority of your portfolio should be in India. Then what is the rationale for investing in the US market? The reasons are threefold.
Diversifying your portfolio risks and returns: Instead of being concentrated in India only, as much as it is in global stocks, the markets are subject to somewhat different parameters and the correlation is low.
Benefiting from global fund flows: The growth of the Indian market, of late, is driven largely by domestic investors than foreign portfolio investors. This imparts strength to our market. You can also benefit from the global fund flows.
INR depreciation: Through the mutual fund route, while you will be investing in Indian rupees, the investment of your money in stocks abroad happens in US dollars. When you redeem, assuming INR depreciates, which is likely, you get a higher converted value. This is over and above your returns from the fund based on market movement.
Your investment avenues
A mutual fund is the convenient route for taking the exposure, rather than purchasing stocks directly. Within mutual fund schemes that facilitate your investments abroad, there are multiple formats.
There are fund of funds (FoFs) that invest in one or more funds, thus making the underlying fund(s) available to the investor of the FoF.
There are exchange-traded funds (ETFs) that are listed at stock exchanges in India, i.e. NSE/BSE, which invest in stocks abroad. For investing in ETFs, you require a demat account and trading account with a stock broker.
There are index funds available in India that invest in stocks abroad. These are referred to as index funds as the designated index is followed and the fund manager does not take any active decision in fund management.
For clarity, ETFs also follow the designated index, but these are referred to as ETFs as your liquidity—your purchase and sales—is only at the stock exchange and not with the mutual fund. In that sense, index funds are preferable as you can buy/sell with the mutual fund. For an index fund, you are not dependent on the extent of liquidity available at the stock exchange. Both index funds and ETFs are classified as passive funds.
To illustrate the portfolio composition of international funds, let us take an index fund. ICICI Prudential has come out with a new fund offer (NFO) of Nasdaq 100 Index Fund. This will replicate the Nasdaq 100 index stocks. The top five constituents of this index are Apple (11.3%), Microsoft (10%), Amazon (7.6%), Alphabet (Google) (4%) and Facebook (4%). Sector-wise, information technology comprises 44% of Nasdaq 100, communication 29% and consumer discretionary 15%.
For your fund selection, particularly passively managed international funds, past record is not relevant; it is about replicating the index and the returns from stocks in the index over a long horizon. Volatility can happen in any market, India or the US or any country. Though market sentiments globally are inter-related as information flows instantly, history shows that returns are different. If we plot year-wise returns from various markets e.g. US, India, European countries, China, Japan, etc., it shows that each year, returns vary significantly. And that effectively diversifies your portfolio. You have to decide your allocation to equity and debt, and within equity, to Indian and global.
To be noted, global funds are taxed as debt, even though the underlying investments are in equity. Your investments should anyways be meant for a long horizon; over a holding period of three years, you get the benefit of indexation. The concept of indexation is that while computing long-term capital gains tax on your debt fund investments, you get a benefit linked to inflation. To the extent allowed by the tax authority, your purchase cost gets indexed up or marked up, and you pay tax only on the net differential. This significantly reduces your tax payable.