Moody’s on Monday downgraded India’s sovereign rating by one notch to Baa3—the lowest investment grade—with a negative outlook. This was the first downgrade by the rating agency for India in 22 years.
Most Indian investors have a vast majority of their equity and debt investments in India, a phenomenon called ‘home bias.’ Mint spoke to financial planners on whether Indian equity or debt investors need to adjust their portfolios in response to the rating downgrade.
A rating downgrade does not directly affect the government’s ability to repay debt to its own citizens in its own currency. This is because the government has the power to print more currency if its finances deteriorate. However, it can affect the flow of foreign investment into India’s equity and debt markets as foreign institutions become wary of the overall economy.
This can worsen the returns that domestic Indian investors get by investing in their own country. One solution is to invest abroad through mutual funds. These funds are denominated in the Indian rupee and function just like any other mutual funds focused on domestic markets. However, they deliver returns from investing in markets such as the US, Europe or China. Capital gains in them are taxed in the same manner as debt funds—20% with indexation for holding periods of more than three years and slab rate for shorter holding periods.
Shyam Sekhar, founder and chief ideator, iThought Advisory, dismissed the idea that investors should allocate more money to foreign markets. “The problem is one of global growth and not just India's. The correct response is a defensive asset allocation weighted towards defensive stocks, debt funds and gold. You can start a small SIP in a US fund, but investing in the US in a big way is not a solution," he said.
Mrin Agarwal, founder Finsafe India Pvt Ltd. and co-founder Womantra also took a relatively conservative approach. “Investors should invest up to 10% of their portfolios in international stocks. But this should be done through Indian funds, which allocate a part of their portfolio to foreign stocks rather than feeder funds," she said.
A feeder fund focuses on a particular geography such as Europe or a theme such as global tech stocks. A diversified fund like PPFAS Long Term Equity invests up to 65% of its assets in Indian stocks and 35% in foreign stocks. This allows it to be treated in the same manner as an Indian equity fund for tax purposes.
Agarwal highlighted the problem of understanding which international market will do well and which will not. “For example, the US market has done very well in the last five-seven years but Europe has not," she said. Over the past five years and seven years, Nifty50 (as measured through NiftyBees, a large exchange-traded fund or ETF) has delivered returns of 4.26% and 8.46%, respectively. This compares poorly to 19.72% and 22.61% given by the Nasdaq 100, respectively, which is tracked by the Motilal Oswal Nasdaq ETF. All these returns are rupee-denominated. However, funds tracking European markets have delivered -2 to -4% CAGR over the past five years (most do not have a longer history), lower than Indian markets.
Some are betting bigger on international diversification. "Investors should be comfortable placing up to 50% of their equity portfolios in broad-based international index funds such as the Motilal Oswal S&P 500 Fund of Funds (FoF) and Nasdaq FoF. These are passively managed and low cost. Another good alternative is Parag Parikh Long Term Equity Fund, which gives international diversification with beneficial taxation. There is no particular reason to believe India will always outperform or a divine destiny that we will do so," said Kunal Bajaj, head, Mobikwik Wealth. Mobikwik is a Sebi registered investment advisor (RIA) through its group company Harvest Fintech Pvt Ltd. A fund of funds (FoF) is also a passive instrument like an ETF. However, you do not need a demat and trading account to buy it, you can do so directly from the fund house just like a regular mutual fund.
Some exposure to international funds can enhance an investor’s returns and reduce risk. This must be tailored to your risk appetite and understanding of the foreign market in question.