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The US Federal Reserve recently suggested that it could start reversing its pandemic stimulus programme in November. That has brought back memories of the 2013 market sell-off, which is commonly called the taper tantrum.

To combat the economic slowdown due to covid, the Fed had in March 2020 cut interest rates to near zero and started its $120 billion in monthly asset purchases. The tapering will represent a major step in monetary policy normalization.

In recent history, the US had adopted the quantitative easing strategy after the global financial crisis of 2008. The easing programme continued for five years and the Fed began tapering in 2013, which caused a major sell-off in the market.

“The tapering programme (in 2013) came as a surprise to the financial markets and hence caused a knee-jerk reaction. The US stock markets saw volatility and sell-offs, but they eventually recovered. The biggest impact was on emerging markets (EMs) because foreign investors reallocated their funds to the US after withdrawing funds from the stock markets in these countries," said Viram Shah, co-founder and chief executive officer, Vested Finance.

 

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A taper often results in global investors repositioning their portfolios, which impacts the fund flows into India. However, since 2013, many Indian investors have started to look at opportunities abroad with an aim to diversify portfolios. These investors in global equities, predominantly the US, are now a worried lot.

Experts say that unlike in 2013, this time the Fed has been giving enough warnings about the tapering and, therefore, we are unlikely to see knee-jerk reactions like the last time.

Nonetheless, volatility is expected to spike during the initial tapering months, and markets can become choppy. “The tapering also indicates that the economy is returning to normalcy, and we can expect corporate earnings to improve. As a result, it is ultimately positive for equities," said Viraj Nanda, CEO, Globalise.

Thanks to the loose monetary policy and low interest rates, already we have high valuations across multiple assets from public to private markets. The Dow Jones Industrial Average has spiked over 80% since the March 2020 lows.

“The biggest unknown though is what will happen to asset prices and valuations going forward. What will the shift away from easy money do to the prices of such assets is what is to be seen. Unfortunately, it’s very difficult to predict how this will play out," said Shah.

Experts suggest that to manage the impact of volatility, one should diversify across asset classes and sectors as much as possible. Moreover, volatility can be beneficial for long-term investors by dollar-cost averaging over a period of time.

But could it be a prudent strategy to take some profits off the table in global portfolios? The tapering is expected to affect EM equities more than developed market ones. “Global headwinds and tighter global financial conditions may imply that FPIs ask for a higher EM risk premium, which could pressure EM assets, including India. We note that India’s real rates have been negative and among the lowest in the EM space," said Madhavi Arora, lead economist, Emkay Global Financial Services Ltd.

Rather than taking profits off the table, it might be prudent to rebalance a global portfolio both at the regional and sectoral levels.

Moreover, investors looking to trim their global portfolio need to keep in mind the tax angle.

“We can expect a few to actively book profits. However, many in India will be wary due to the tax implications of booking these profits if they have invested for less than 2 years in US stocks, as the capital gains will be a part of their marginal income. Indian investors may need to understand this clearly before taking any decision on it," said Swastik Nigam, CEO, Winvesta.

With most major markets historically moving in tandem with the US, can higher exposure to any country, for example, China, reduce volatility risks? The regulatory crackdown on industries like private tuitions and online gaming, and financial troubles with Evergrande, a real estate developer, have caused a sharp fall in Chinese markets in the recent past.

According to Globalise’s Nanda, the Fed tapering and the affiliated rate hikes would make it harder to borrow in dollars. “Fund flows would also move into the US away from EMs as US rates become attractive. So, increasing exposure to EMs would not help reduce volatility. The US dollar would also strengthen versus EM currencies, adding an additional layer of issues for EM equities."

Investors should also keep in mind that concentrated exposure to any region increases the volatility risks of a portfolio. However, volatility is the price that one pays for staying invested in the markets. Therefore, taking any knee-jerk decisions to reduce volatility is short-term thinking and causes unnecessary deviation from one’s investing strategy.

“The key is to build a portfolio on a sound foundation of diversification and consistent investing. Then, one should only spectate when the market is highly volatile without trying to time the market," said Shah.

The majority of investors in India have just recently started investing globally. Advisers recommend that retail investors can take portfolio exposure of 5-10% towards international investments, and they should employ a long-term strategy without minding short-term fluctuations.

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