Why index funds are best bets if you want to invest internationally

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In the prevailing scenario, one can say with confidence that India is one of the fastest growing economies. However, India’s GDP represents only 3% of World GDP and roughly the same percentage of global stock market capitalization.

Globally, a lot of innovation is taking place through disruption of various traditional industries. Such innovation and disruption creates investment opportunities across geographies. Such opportunities are very limited in India in the listed space. Hence, to participate meaningfully in these opportunities, investors need to take exposure to several themes or emerging mega-trends outside India.

Reasons for Investing Internationally:

Winners keep changing:

Every country has its own strengths and weaknesses, and reactions to global news flows can be consequently different.
As can be seen in the chart above, no single country/region has been the best performer consecutively for a prolonged time period. In the last 10 years, the US has been the top performer in 6 years but only twice consecutively. International investments reduce single country/region-specific risk at portfolio level.

Correlation benefits:
Correlation shows the strength of relationship between two variables, in this case the stock market performance of one country vis-à-vis the other.

As against the general notion that Indian & US equity markets have high positive correlation, there have been periods of divergent movements, e.g. 2011, 2013, 2015-16, as given in the previous chart. Also, in the last 10 years, the correlation between India & US has been only 0.29.

Hedge against INR depreciation:
International exposure also carries with it exposure to different currencies. Whenever there is any depreciation in INR, the global portfolio could earn higher INR returns, which is depicted in the chart of the US S&P 500 index below.

Ability to participate in global themes:
Though India is one of the fastest growing economies in the world, it still lags behind the advanced economies with respect to innovation, since the major technology centric firms operate globally. E.g. names like Facebook, Amazon, Apple, Netflix, Google, etc. are not listed on Indian bourses.

Popular themes that are emanating across the globe are robotics, artificial intelligence, electric vehicles, industrial automations, e-commerce and cloud computing. Since these themes are expected to shape our future, it makes sense for domestic investors to participate in such global themes.

To summarize, international investing helps in diversifying single country risk, provides correlation benefits, provides currency diversification, and the opportunity to invest in some of the leading global brands & themes.

Modes of International Investing:
International Investing is possible either through domestic Mutual Funds, either through Index funds which mirror global indices, or actively managed funds, or by investing directly in foreign currency through the Liberalized Remittance Scheme (LRS).

Investing via domestic funds is preferable since the money remains INR denominated and is subject to domestic taxation. Funds which invest in international equities are taxed as fixed income mutual funds in India, i.e. subject to LTCG @20% with indexation if held for > 3 years, or subject to STCG @MMR if held for < 3 years.

Benefits of Index Funds in International Investing
For domestic investors, passive funds or Index funds are the best way to invest in international markets.

Index funds aim to replicate the performance of an index. The case for Index funds is pretty much proven in the US, where almost 50% of the assets managed through that mutual fund industry is covered through passively managed funds. One of the key reasons for this is the information efficiency which is prevalent in US & other Developed markets. This is makes it difficult for a global active manager to consistently outperform the benchmark indices e.g. the S&P500, Nasdaq100, MSCI World Index, etc.

Global Index funds are more economical since they do not have the management & operational expenses associated with actively managed funds.

Furthermore, global index funds provide access to global leaders across industries and access to emerging themes or mega-trends.

Amongst the opportunities available for domestic investors:
The Motilal Oswal S&P 500 Index Fund replicates the S&P500 index which includes the top 500 companies in the United States covering all 11 Global Industry Classification Standard (GICS) sectors making it a broad based diversified index. This index includes top 100 non-financial companies and the companies that form the top 10 holdings include Microsoft, Apple, Amazon, Tesla, Alphabet, Facebook, Nvidia & NetFlix.

The Motilal Oswal NASDAQ 100 ETF & FoF offer an opportunity to invest in global technology companies that are part of the NASDAQ 100 Index, which covers the top 100 non-financial companies.

The HDFC Developed World Indexes Fund of Funds tracks the performance of the MSCI World Index which covers 23 developed markets, covers approximately 85% of the free float-adjusted market capitalization in each country, through 1500+ constituents.

(The author, Nitin Shanbhag, is Senior Group Vice President – Investment Products, Motilal Oswal Private Wealth. The views are his own.)

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