In the last 9 months, the Indian equity market has been underperforming global assets. Therein lies an opportunity
Investors can diversify out of Indian equities into debt and global assets via RBI’s Liberalised Remittance Scheme or even with exchange-traded funds in India, against rupee payment
In May 2019, the Narendra Modi-led government was re-elected with a powerful mandate. Hopes for a strong economic recovery rode high, and in the second half of the month, Indian equities bounced almost 10%. Earlier that month, I had taken a contrarian position, and tweeted that gold would outperform the National Stock Exchange’s benchmark Nifty 50 index. Well, it happened more quickly than I anticipated. Between 2 May 2019 and 20 February 2020, gold appreciated 23% more than the Nifty.
Then, somebody who follows US equity markets suggested I check the leading US indices too. I ran the numbers for the two top US indices—the Dow Jones Industrial Average or Dow, and the Nasdaq Composite. To compare them with the Nifty, I had to convert them into rupees. Between 2 May 2019 and 20 February 2020, the relative appreciation of the Nasdaq to the Nifty, in rupee terms, has been almost 20.5%.The Dow has not been quite as rewarding, but still returned 11% more than the Nifty.
In absolute terms, too, the Nifty has not returned much, appreciating by barely 4% during the same period. Most Indian equity investors would have earned even less, as few mutual funds keep up with the index. The broader market, as measured by the Nifty 500 index, has returned slightly less, at 3%.
The pattern is very clear—over the last nine months, the Indian equity market has hugely underperforming global assets, and is not even keeping up with the cost of living. The past is, of course, not a reliable guide to the future, so one must pause here and ask whether there is a good chance of the stock market rebounding soon. Quite clearly, the economy is showing no signs of recovery, and the recent Union budget acknowledges that the government has limited fiscal room to stimulate the economy.
These efforts will be further choked if the government’s revenue projections don’t materialize. Tax revenues could well be lower than budget projections if the economy grows slower than expected. The budget also makes optimistic projections for non-tax revenues, largely from selling shares in public sector units; if these sales don’t materialize, the government will have to further cut back on spending. The country’s history of divestment is a sobering one, and one would be extremely surprised if a stake sale in Life Insurance Corporation of India happens by March 2021.
The spread of the coronavirus injects another layer of pessimism into the outlook for the Indian economy.
Clearly, there has never been a better time to diversify out of Indian equities, both into debt and global assets. Investing overseas has been made much easier by the Reserve Bank of India’s (RBI’s) Liberalised Remittance Scheme (LRS). Under LRS, all resident individuals, including minors, are allowed to freely remit up to $250,000 per fiscal year for any permissible current or capital account transaction or a combination of both. That said, a fair amount of diversification into global assets is possible via funds, especially exchange-traded funds (ETFs) available in India, against rupee payment. ETFs are mutual funds that mimic an index and list on the stock exchange.
The world of global equities is dominated by US listed companies, which account for roughly 50% of the total market capitalization.
When India was growing at 8% per annum, it made sense for domestic investors to focus entirely on local equities. Over the next few years, in contrast, our growth prospects look considerably weaker, and it would be a grave mistake to ignore the largest equity market in the world. Since we all look to recent history for reassurance, it helps that over the last year, US equities have outperformed Indian ones.
Thanks to the easy money policies being followed by central banks, US equities are not cheap. However, the downside risks to US growth are lower than India’s and correspondingly, US equities represent much less downside risk than Indian ones. Sure, US equities will be pressured by a cyclical downturn in its economy; but the mismatch between equity pricing and growth is nowhere near as high as in India.
A balanced approach to risk demands a good representation of US equities in any substantial asset portfolio. There are several ways to buy US equities—both onshore and offshore.
The SPDR S&P ETF (SPY:US) tracks movements in the S&P 500, a broad-based US index. With a market cap of over $300 billion, it is an accurate mirror of US stocks, and has returned 22.5%—in dollar terms—over the last year.
Indian ETFs also try to capture movements in US equities. Virtually every Indian asset management company has several schemes for the purpose. They haven’t been very popular, as Indian investors seem focused on the domestic market, but this very fact is as good a contrarian signal as any.The corollary to this is that Indian funds offering US equities have tiny amounts under management, typically under ₹10 crore. This makes it really difficult for fund managers to map the US market at a low cost.
Of the ones I studied, the Nippon India US Equity Opportunities Fund has had the best return, at 23%. However, Indian funds typically carry exit loads, and management fees are higher than their US counterparts; if one is going to invest in US equities, this is best done with funds held abroad for the purpose, as allowed under LRS.
Within the universe of US companies, those represented on the Nasdaq have been absolutely outstanding performers. They include the trillion-dollar giants like Apple, Google and Microsoft; over the last year, the Nasdaq has returned a mouth-watering 35%. I have been invested in the Nasdaq via the Indian ETF—Motilal Oswal Nasdaq 100 ETF—and it has done an excellent job of matching returns on the target index. It helps that the fund now manages more than ₹200 crore of Indian money.
Two words of caution, though. While an ETF sees decent volume on most days, the total value traded is rarely more than a couple of crores of rupees, so one has to ensure that large purchases and sales don’t pressure the trading price. Secondly, in the past, when there was uncertainty around the rupee, ETF sold at a substantial premium to its net asset value, which represents a fund’s per share market value. For that reason, if one is planning a substantial investment in US tech companies, it makes more sense to invest via global markets.
On US exchanges, the most widely used tech-targeted ETF is the so-called CUBE, the Invesco QQQ. With almost $100 billion under management, it is extremely liquid and over the last year has returned 35%, tracking the Nasdaq 100 Index both accurately and at low cost.
Given the depth of US markets, one could fine-tune the nature of tech investments, and pick, for example, a US-based ETF specializing in biotech, which many see as the industry of the future. For instance, the iShares Nasdaq Biotechnology ETF does just this. Performance over the last year has been decent, at 12.98% in dollar terms. Do note, this is just one of many investment possibilities into the future of tech via US-based ETFs.
US equities represent 50% of the market capitalization of global listed companies, and Indian equities less than 3%. Most Indian investors tend to focus on domestic equities, and a few on US market. But it is worth remembering that this leaves out equities which represent almost half of global market cap. While one could pick ETFs for virtually any nation or industry vertical, a well-diversified asset portfolio should consider a broader representation than just the US and India.
The MSCI All Country World Index (ACWI) tracks companies across the world for a global share index. Over the year to 21 February 2000, ACWI returned 14%, and provides the most diversified index of global equities. Of the various ETFs that try to shadow ACWI, the largest is the iShares MSCI ACWI, which holds over 1,200 equities across the globe, in both developed and developing markets. With over $10 billion under management, the tracking error of this fund is low.
Some Indian asset management firms have global equity funds, but their exit loads and low volumes make them susceptible to investing friction and tracking errors. Again, if one wants a broad-based exposure to global equities, the best way to do it is from funds held overseas, as allowed by RBI norms.
All that glitters
Gold has a long history as the most global financial asset. And it is the ideal hedge for the times, with uncertainty in economic growth, trade and currency on the one hand, and easy money on the other. The coronavirus outbreak has increased the shift to safe-haven gold.
Fact is, if it was not coronavirus, it would have been something else. When you have huge sums of money being pumped into weak economies, the moment there is a blip, some of that money will flow away from equities into gold and other safe assets.
Since 2007, the most convenient way to invest in gold has been via gold ETFs. The most deeply traded ETF on Indian market is the Nippon India ETF Gold BeES, also called the Goldbee. On 20 February, it closed at 36.82, up more than 35% over the last year.
There are several other gold ETFs, too, which track the price of gold. The only significant divergence between Indian gold ETFs and global bullion prices comes from the import duty on the metal. However, I don’t see this coming down in a hurry, so there is no reason to invest one’s LRS entitlement in gold.
Another related asset class is gold funds that track the equities of mining firms which produce gold and other precious metals. In India, the DSP World Gold Fund does this, and has returned about 23% over the last year.
Gold prices have an impact on mining firms with a lag. So if the price of the precious metal stays up for extended period, the benefits to mining firms could be disproportionately high, and it might be worth adding some of these to the mix.
Interestingly, the DSP World Gold Fund is a “fund of funds", and doesn’t directly buy shares of mining firms; instead it tracks a US-based fund which does that—the BlackRock World Gold Fund, which “invests at least 70% of its total assets in the equity securities of companies whose predominant economic activity is gold mining. It may also invest in the equity of companies involved in mining of other metals". If you hold investment funds overseas, it would be better to buy this fund, as it has a slightly better return than the DSP gold fund, and will track them at a lower cost.
India’s richest families began to diversify their asset base decades ago. The Aditya Birla Group was the leader in this regard, but was soon followed by the Tatas, the Adanis and a host of others. Global diversification is a major tool for dampening the risk to one’s financial holdings. Between LRS and offerings on the Indian market, it has never been easier for the domestic investor to do this. I would urge you to bite this bullet.