Home / Opinion / Pick stable stocks across the globe to form core portfolio

William Shakespeare’s famous quote “The world is my oyster", is apt for equity investments today. Consider this: opening an oyster’s shell requires a lot of hard work, and most of the time you just get an oyster, but sometimes you do find a pearl. If we were to use this analogy to equity investments, a pearl can be defined as a stock of high quality that is significantly undervalued. And this the pearl that a smart investor is looking for. Her chances of finding that pearl are enhanced significantly if she expands her investment horizon to include global stock markets.

While the Indian equity market has thousands of listed stocks, there are only a few of substantial size. Globally, large-cap stocks are defined as those with a market capitalisation of more than $10 billion. In the domestic market, there are 30-35 stocks that qualify at different market levels as large-caps. There are about 80 stocks which would qualify as mid-caps with market caps in the range of $2-10 billion, and about 225 which would qualify as small caps. The remaining are micro-caps or smaller. But how does it matter?

A large-cap is typically a company with a stable business model. But mid- or small-caps might not be as stable. So it is important to compose the core of your equity portfolio with large-cap stocks. Since one should have at least 20-25 companies in the core portfolio, there is hardly any choice if one has to choose 20 stocks from 35. Now, if one just adds the US stock market to her equity horizon, she would have about 400 to 500 large-caps. Include the European, the UK and Japanese stock markets, and you will have about 1,000-1,200 large-cap stocks to choose from. So you see, by adding just four new markets to your portfolio, the size of the investment universe has increased nearly 40-fold. Now this expanded exposure provides much higher chances of finding undervalued stocks. Since one is choosing stocks from the developed markets, the chances of finding stable companies would also be higher. Revenues of these companies is huge. These companies have exposure to numerous countries and currencies with diversified macroeconomic variables, and thus, provide more stability across business cycles.

An exposure to only Indian companies would be highly concentrated and depend mostly on our economy and business cycles. Also, a purely Indian portfolio of large-caps would have no consumer service businesses and only a few healthcare companies. But it would have a large concentration of financials and banks. In the technology sector, the Indian portfolio would have mostly outsourced technology services companies, while the global portfolio would have technology products and platform providers as well.

Although a home-bias is common in investors worldwide, it is severe in the case of Indians. Most Indian investors have no exposure to any other equity market. This makes their portfolios highly vulnerable to unfavourable developments in the Indian economy. Over the long run, our economy, just like all other economies, will go through ups and downs of business and economic cycles. At such times, a purely Indian portfolio becomes difficult to hold on to. A globally diversified portfolio would have companies which would be doing well while the Indian economy goes through a slowdown. Sometimes the Indian companies could be facing adverse effects of inflation or interest rates or higher debt. A global portfolio provides stability against such macroeconomic volatility.

Also, the valuations of companies are different across countries. Some capital markets are much more undervalued compared with others despite similar companies with global revenue exposure. That allows one to capture the mis-pricing. If one wanted to focus on high return on equity (ROE) companies, in India there would be about 80-100 companies with ROE above 20%. Global markets would provide an additional 250-300 companies. The Indian companies of high quality stocks are available at an average price-earnings (P-E) ratio of 32, while global companies of similar quality are available at an average P-E ratio of 19.

Most Indian investors are not aware that they can buy global stocks. The Reserve Bank of India (RBI) allows Indian investors to buy global equities under the Liberalised Remittance Scheme (LRS), where one can remit $250,000 per person per year. A family of four can together, thus, remit $1 million per year, and hence for most investors, including high net worth investors, the limit is substantial and they should take advantage of it. Also keep in mind the rupee depreciation of approximately 4-6% per annum against the US dollar. This, with the fact that at least 40% of our expenses are dollar-dependent, directly or indirectly, should be reason enough to have a significant exposure to global stocks.

But here is word of caution before you buy your first global stock. If you have not yet developed the ability to pick individual stocks in the domestic market, then chances are you would not be able to do so in global markets. So stick to mutual funds. You can choose from any global mutual fund, including those outside India, under the LRS scheme. But if you feel confident that you know how to create a strong portfolio and manage it, and are doing so in India, you can invest in global markets as well.

Veteran investor, John Templeton, invested in global markets and made money when it was difficult to get data. Today, it is available at your finger tips. So, go ahead, and make the world your oyster, and use your value investing skills to pick 25-50 pearls to create a diversified, large-cap, high quality, undervalued portfolio that could be expected to provide a stable core and satisfactory returns.

Vikas Gupta is executive vice-president and chief investment officer, ArthVeda Capital

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