Global ETFs can help portfolios truly diversify

Exchange-traded funds (ETFs) have revolutionized retail investment. By packaging slices of the market into liquid and tradeable vehicles, ETFs provide an investor with a low-cost and transparent way to invest in indices, commodities, foreign markets and more.

In the Indian markets, ETFs have just started to become popular. Over the last five years investments in Indian ETFs have seen a 30-time volume growth, most of it going towards Nifty50 ETFs. Although growth is largely driven by institutions, as awareness among the retail investor base grows and diverse ETFs become available, Indian retail investors will also start looking at ETFs. One of the key reasons why the awareness about ETFs is still low in India is because of their low expense ratio. While low expense ratios are good for the end investor, mutual fund distributors, one of the largest sales channels for investment products, do not have as much incentive to encourage customers to invest via ETFs.

In the US markets, however, ETFs have gained immense popularity since the financial crisis and are now a well-recognized instrument among both retail as well as institutional investors. Today trading in ETFs account for about 25% of the daily volume in US stock markets and can go up to 40% on volatile days.

Out of the different types of ETFs, the one that stands out to me is international ETF. Never before has it been this easy to invest in markets outside our home country. Since the Indian ETF market is still evolving, there are only a few international ETFs like the Motilal Oswal S&P 500 available here. However, through the US exchanges (which an Indian can now access easily), one can access a variety of such ETFs. Under the Reserve Bank of India’s Liberalised Remittance Scheme, you can invest up to $250,000 each year in stocks, bonds and ETFs. International ETFs are taxed in the same manner as debt funds. If held for more than three years, a capital gains tax of 20% applies along with the benefit of indexation. For shorter holding periods, you pay tax at the slab rate on capital gains. Remember that all international assets must be reported in Schedule FA of your income tax return every year.

There are primarily two types of international ETFs—country-specific and country-neutral. Country-specific ETFs allow you to invest in a specific country. For example, VanEck Vectors Vietnam ETF gives you the opportunity to invest in the Vietnam equity market. On the other hand, country-neutral ETFs allow you to invest in the entire world. We will look at three interesting investment opportunities that country-neutral ETFs provide.

Own the entire world’s equity or bonds: Through Vanguard’s Total World Stock ETF or the Vanguard Total World Bond ETF, you can basically invest in the entire world’s stocks or bonds in one go at a low expense ratio of 0.08% and 0.06% respectively. An investor could look at VT as a replacement for the S&P 500 in their portfolio. The advantage of VT over the S&P 500, even though both have the same top 10 holdings, is that VT has more than 45% of its assets invested outside of the US, reducing exposure to the US economy. As of December 2020, VT has annually returned 10.3% over the last five years (this is in dollars, rupee depreciation adds to the returns).

Invest in top companies worldwide: If you’re investing via the US markets and don’t want 100% exposure to US companies, then iShares’ Global 100 ETF can help. This ETF invests in 100 of the largest companies across developed and emerging markets. As on 9 December 2020, this ETF returned 12.84% annually over the past five years. Some non-US companies that are part of this ETF are Samsung, Nestle, Novartis, Toyota and Honda.

Bet on a sector globally: Lastly, you can look at country-neutral ETFs to invest in a sector at a global level. Some of the global sector-based ETFs worth considering are Global Clean Energy iShares, iShares Global REIT ETF or iShares MSCI Global Silver and Metals Miners ETF. Global Clean Energy, in particular, is a unique ETF that provides exposure to companies that produce energy from solar, wind and other renewable sources. It has had a great run over the last three years providing 29.6% of annual returns (as on 9 December 2020).

Country-neutral ETFs provide a great opportunity to diversify away country risk. They give you instant global access via a single instrument, so why not make the most of it. Do remember that these ETFs are appropriate for long-term investing only.

Viram Shah is co-founder, Vested Finance