Geographic Diversification

Geographic Diversification

Geographic Diversification

Case For Geographic Diversification to US Equities for Indian Investors
1. Background

Investing outside one’s home market has diversified the returns of what had been a purely domestic market portfolio, on average and across time.

The rationale for diversification is clear—domestic equities tend to be more exposed to the narrower economic and market forces of their home market while stocks outside an investor’s home market tend to offer exposure to a wider array of economic and market forces. These differing economies and markets produce returns that can vary from those of an investor’s home market.

Simply focusing on domestic companies means an investor has no stake in leading global companies that are domiciled outside their home market. Additionally, foreign exchange can be a diversifier for an investor’s portfolio.

Regardless of where they live, investors have a significant opportunity to diversify their equity portfolios by investing outside their home market. Despite this opportunity, investors on average have maintained allocations to their home country that have been significantly larger than the country’s market-capitalization weight in a globally diversified equity index.

International investing also offers broad diversification across investment sizes and styles, geographies, and asset classes. Each country and region has its own unique set of attractive investment opportunities based on its stage of economic development, demographics, resources, and other factors. Developed markets, such as the U.S., Japan, and Western Europe, have strong growth prospects in technology and services. Resource-rich nations like Canada, Australia, and Russia are currently enjoying export booms based on oil, gas, minerals, and even agricultural products.

2. Role of Transnational Corporations

One of the key highlights that has happened over the last couple of decades is the evolution of large transnational corporations that can work without borders. (e.g. Apple, Google). These entities seem to capture large portion of the growth pie in developing economies like India.

Indian investors are unable to capture the same through the local investments as these companies are not listed in the Indian markets

3. Summary Observations

Geographical diversification is a way of reducing portfolio risk by avoiding excessive concentration in any one market.

Geographical diversification can involve investing in developing/ developed countries that offer greater growth potential than home economies.

Transnational corporations have operated without any borders and investors in India are missing a part of the gains of share ownership while a large amount of their expenditure wallet share are being captured by these companies.

4. Indian Market

India as a market has significant potential given that it is a developing economy with higher growth rates than the developed world.

However, as a country there are risks of instability due to the political and economic policies. The risks to India can be observed from the global credit ratings which ranks the country at BBB just at investment grade. India has had a chronic issue of higher inflation rates and large currency depreciation. This also leads to higher interest rates. This has been reversing ever since the monetary policy framework has been put in place.

However, the current crisis will test the government’s ability to manage the balance between social stability and financial stability.

Corporate India also has been going through the challenges of incremental growth being captured by large transnational corporations given that the local companies have been under pressure due to financing problems as well as competitive pressures due to lower economies of scale besides shifts in technology

5. Geography for Diversification
Indian investors have large portion of their wealth in the local market. Given India as an emerging market there is a logical case for some diversifications to the developed world. Among the developed markets the largest market with the maximum listed transnational companies is the US markets.
6. US Markets

The fact that many of the largest foreign firms are listed on U.S. stock exchanges, The U.S. stock market has over 6,000 companies valued collectively at approximately $15 trillion.

US equities are a core component of almost every major global equity or sector portfolio/index.

On average, US equities represent close to 50% of global equity indices. US equities represent over 75% of the global information technology sector and over 50% of the global healthcare, consumer discretionary, consumer staples, utilities, and industrials sectors.

It is among the most well diversified markets in the world. The top 2 sectors (Financials & Technology) account for only ~34% of US equity market capitalization.

The US equity market provides investors access to a universe of companies exhibiting huge innovation and leading many global trends & investment themes. The U.S. is home to many companies in leading growth fields such as technology, biotech and communications. Technology leaders include high-quality companies like Mastercard, and Alphabet Inc. Some technology investments help companies remain competitive in a globalised economy, driving lower costs and improving productivity. Others have strong competitive positions in the marketplace and are constantly innovating, that can lead to superior and sustained profitability.

Additionally, US has the benefit of being the reserve currency of the world thereby the currency diversification is an added advantage.

7. Regulatory framework for India
India has capital controls which prevent residents from freely converting their assets into foreign assets. There have been some relaxations over the years namely

The above two mechanisms have been used by Investors to diversify to investments outside India. The first has been used either to open offshore accounts with wealth management firms outside India or buy foreign stocks through some investment platforms that allow such purchases.

The mutual fund mechanism has also been showing significant growth over the years with investors finding it to be simple to operate and local asset management firms launching schemes that meet with investor’s needs.

8. Regulatory framework for India

Indian residents are taxed on their global incomes hence income from investments outside India are taxed in the home country. There are double tax treaties for certain jurisdictions that provide some relief on the incidence of tax.

The taxation on the mutual fund platform is restricted to purely domestic taxation as the units are issued and extinguished in India. The tax for offshore mutual fund schemes is similar to debt funds where long term capital gains are applicable after holding for three years.

9. Offshore schemes universe with their performances
Enclosed below are the universe of schemes with US or global allocations
Performances of the schemes relative to the Indian Index
10. Conclusion

1. Every individual is allowed to remit $2,50,000 every financial year without any end use requirements

2. Indian mutual fund industry has been allowed to launch schemes investing outside India with a cap of $5bn.

Scheme Name
Month End
Franklin India Feeder – Franklin U.S. Opportunities Fund(G)
Motilal Oswal Nasdaq 100 ETF
ICICI Pru US Bluechip Equity Fund(G)
Motilal Oswal S&P 500 Index Fund-Reg(G)
DSP US Flexible Equity Fund-Reg(G)
PGIM India Global Equity Opp Fund(G)
ICICI Pru Global Stable Equity Fund(FOF)(G)
Sundaram Global Brand Fund(G)
Edelweiss US Value Equity Offshore Fund-Reg(G)
DSP Global Allocation Fund-Reg(G)
ICICI Pru Global Advantage Fund(FOF)(G)
Principal Global Opportunities Fund(G)
Invesco India Feeder – Invesco Global Equity Income Fund(G)
HSBC Global Consumer Opportunities Fund (HGCOF)-Reg(G)

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