Much has been said about how Indians have traditionally had a huge ‘domestic bias’ in their investment portfolios. I am often asked by investors – “India is doing so well, why should I consider investing overseas?” An argument is then made as to how well the Indian equity markets have performed in the recent past. Amid this perception and the LRS (Liberalized Remittance Scheme) remittance limit, Indian investors stuck to domestic investments. However, prudent investors understand the importance of global portfolio diversification and that it is not a fad or a ‘time is not right’ issue. This is a long term, strategic move for your portfolio and family legacy planning.
Comparing Global Returns: Apples and Oranges?
First, let us see whether the Indian equity markets have really outperformed the global markets or not.
After hearing a lot from Indian investors about how well the domestic markets have performed, LCR Wealth conducted an analysis to compare the performance of the markets in India, USA, Brazil and Europe. The analysis was based on a period of 22 years, from 31 December 1999 to the end of 2021. And sure enough, the Indian Nifty 50 outperformed the other indices with a modest return of 1,065%, as against the S&P 500’s 386% return, IBOVESPA’s 513% and the Euro Stoxx 50’s 12.5% return.
On adjusting the nominal return baskets for each currency’s annual inflation rate, the Nifty 50 was still the top performer with an inflation-adjusted return of 213%. The S&P 500 returned 192% after adjusting for inflation, but Ibovespa returned only 58%. (By this time, we’ve lost interest in the Euro Stoxx 50.)
Wait a minute! What about currency exchange rates? Even though the Nifty 50 had higher inflation-adjusted returns than the S&P 500, the rupee did not gain as much as the dollar between 2000 and 2021. Once you adjust for both inflation and FX rates, the Nifty 50 returns 90%. , while the S&P 500 is up 192%. In short, over a 22-year period, the S&P 500 outperformed the other major indices in purchasing power parity (PPP) terms by 100% or more. This improved performance remains the same even if we keep any of the other three currencies constant for the analysis.
This becomes an important consideration, especially if you anticipate dollar-denominated expenses in the future. According to Knight Frank, around 40% of all expenditure incurred by wealthy Indians is dependent on the dollar. This means that changes in the dollar can have a significant impact on the total net worth of households.
portfolio risk management
Diversification and low volatility are important aspects of building a safe portfolio. Volatility of returns is a measure of risk, expressed as a percentage. The higher the percentage volatility, the higher the risk. Investing in different geographies can provide the benefits of diversification and, if planned well, reduce the volatility of your portfolio. For example, the volatility of a 100% Nifty 50 portfolio over a 22 year period is 29.92% with an annualized return of 3.10%. But adding a 20% allocation to the S&P 500 lowers volatility by 2.49%, to 27.43%, while increasing the annualized return by 0.51%, to 3.61%.
One of the main risks in investing is liquidity risk, which is translated as the risk of not being able to convert an investment into cash at the time of need. Developed markets, such as the US, have greater depth and are naturally more liquid. Especially in times of crisis, it pays to invest at least partially in the “safe haven” market. During the global financial crisis of 2008, international investors who made US investments had the flexibility to alter their portfolios due to their relatively more liquid nature. of that market (compared to their home countries). There’s a reason why the best foreign companies seek the largest and most liquid markets to list their shares, and the US remains a popular choice.
Developed markets are also much more efficient, with the market pricing in any new information almost instantaneously. Investor protection is also generally better in more developed markets. Together, these factors lead to better price stability, increased net returns, and less disparity between retail and institutional investors. Also, not participating in overseas markets may leave investors feeling short of quality ideas that are not available in India.
This is not to say that Indian investors should invest only overseas, rather it becomes clear that they should allocate at least a small portion of their portfolio to overseas markets.
Shilpa Menon is Senior Director – India at LCR Capital Partners.
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