As a modern-day investor in the Indian market, the environment for investments has expanded far beyond the boundaries of the domestic market. Although a vastly successful market in terms of its return-oriented offerings to the investor in terms of stocks, the truth of the matter is that it is global diversification that will offer it the ultimate experiences of diversification and mitigation of diversified risks of the economy.
Why Global Diversification Is Essential
International investments provide three key advantages, in addition to what can be gained from a strong domestic portfolio:
Risk Management and Portfolio Stability
A portfolio solely invested in Indian instruments will be vulnerable to country-specific risks. The portfolio will have to face risks relating to inflation in India and the Indian economic cycles. By allocating a portion of capital to international markets, they will be able to reduce the overall volatility associated with the portfolio. The risk will decrease as international markets have a low correlation with the Indian market. It will allow the international market to continue with positive trends in case the Indian market deteriorates.
Access to Unique Growth Sectors
Although there is diversity in the Indian market, there is a lack of representation in some of the fast-growing industries and companies, which drive the worldwide economy. By investing globally, especially in the US, there is exposure to the technology leaders, innovative medical companies and other worldwide leaders, which may not necessarily be listed on the Indian stock exchanges.
The Natural Currency Hedge: Benefiting from INR Depreciation
One of the most compelling arguments for investing globally is the natural hedge it offers for the depreciation of the Indian Rupee (INR). The pattern of depreciation of the INR has shown a consistent fall over the years against major global currencies such as the United States Dollar (USD), as the Rupee has fallen by 85% since 2010.
In the situation where the Indian investor has made an investment in a USD-denominated instrument, the returns are twofold: the return generated by the investment in addition to that derived from an improvement in the Rupee value vis-à-vis the USD. Such an adjustment provides an obvious lift to INR returns, particularly when considering an inflationary environment.
Portfolio Allocation: How Much in INR vs. USD?
The allocation of portfolio assets, how much to hold in INR-denominated assets or in USD-denominated assets, is critical. Though there is no specific answer to this question, financial experts recommend allocation of a small but non-trivial portion of assets abroad.
The allocation of portfolio assets depends heavily on the investor's profile. For a conservative investor, an allocation of 5-10% of the equity portfolio is recommended to focus on core domestic stability while gaining minimal diversification and currency hedge benefits.
For a moderate profile, a 10-15% allocation is suggested as a balanced approach; this allows the investor to benefit from global growth and a stronger currency hedge without incurring excessive regulatory or tax complexity, making it a prudent starting point for most. Finally, for an aggressive investor, a higher exposure of 15-25% is recommended to maximize diversification, access high-growth sectors and leverage the Liberalised Remittance Scheme (LRS) route for direct investment.
The allocation to international funds should be viewed as a part of your overall equity portfolio, not your entire portfolio. For a typical investor, an allocation of 10% to 15% for your overall equity portfolio for USD-denominated international funds would be a good start, as this would account for diversification and also take into account currency hedging associated with international investing.
Investment Avenues for Indian Investors
The two ways by which Indian investors can tap into global markets involve respective considerations:
Mutual Funds and Funds of Funds (FoFs)
This is the simplest and most common route. Indian Asset Management Companies (AMCs) offer:
International Mutual Funds: These funds invest directly in foreign stocks or in a portfolio of international funds.
Funds of Funds (FoFs) and ETFs: These funds focus on overseas Exchange Traded Funds (ETFs), which are tied to international indices (e.g., Nasdaq 100). This option is especially important because it is now allowable under an industry limit of $7 billion imposed by the Reserve Bank of India (RBI), including an extra limit of $1 billion on overseas investing in foreign ETFs. Because of the limit set by the RBI, several overseas funds are currently suspending new subscriptions. But some overseas FoFs investing in ETFs are often under the limit of $1 billion and are thus an accessible alternative.
Liberalised Remittance Scheme (LRS)
For investors with a higher risk appetite and larger capital, the LRS route allows an individual to remit up to $250,000 every financial year directly to invest in foreign stocks, bonds, or real estate. This provides the most direct exposure but requires opening an overseas brokerage account and managing the investments directly.
“ By investing globally, especially in the US, there is exposure to the technology leaders, innovative medical companies and other worldwide leaders, which may not necessarily be listed on the Indian stock exchanges.”
Taxation and Risk Considerations
While the benefits are clear, investors must be mindful of the associated risks and tax implications:
Taxation and Risk Considerations regarding taxation, international mutual funds are generally taxed as non-equity funds in India. Gains held for less than three years are taxed as Short-Term Capital Gains (STCG) at the investor's applicable income tax slab rate, while gains held for more than three years are taxed as Long-Term Capital Gains (LTCG) at 20% with the benefit of indexation. Investors must also consider currency risk: while long-term depreciation of the INR is a benefit, short-term appreciation of the Rupee against the USD can negatively impact the INR-adjusted returns of international investment. Finally, regulatory risk remains a factor, as the RBI's overseas investment limits can be a hurdle, evidenced by the temporary suspension of new subscriptions in many international funds.
The Right Balance for Your Portfolio
Global diversification has ceased to be a luxury and has now become a necessity for the sophisticated Indian investor. By allocating a part of your equity portfolio, ideally around 10-15%, in USD assets via FoF schemes or ETFs or LRS schemes, you can create a stronger and stronger portfolio. The trick is to take a long-term view and focus on quality assets while using globalization as a powerful hedge against market volatility.
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