By Shiv Gupta

It is estimated that more than 80% of portfolios in emerging markets are invested in local markets. This is a case of home market bias, a preference for investing in one’s home country, which emanates, mainly, from the lack of familiarity with and/or inaccessibility of foreign investments.

In India, the percentage is higher, with over 95% of investor assets in domestic markets. This is partly due to the above factors and partly due to structural reasons.

However, in recent years, the superior performance of the S&P 500 and some top technology stocks (FAANG) relative to domestic funds had been a trigger for investors to diversify overseas.

Investments in international equities and debt through the Liberalized Remittance Scheme (LRS) in FY23 surged to USD 1.2bn, a significant increase from FY21. Domestic feeder funds also witnessed strong inflows of about INR 7,900crs in FY21, close to three times the AUM at the beginning of FY21. However, they reached the USD 7 billion limit imposed by the RBI in 2021, thus restricting flows ever since. We hope that this will change at some point soon.
 
International diversification has several advantages – geographic and currency diversification, access to a wider array of investment themes and asset classes, access to growth and innovation, and better risk-adjusted returns given the lower correlations between domestic and international markets. This should be a consideration even today when domestic equities are performing very well. Getting it right, however, calls for a systematic and strategic approach.
 
To the uninitiated, international investing can be complex, and this is further accentuated by the currently elevated macroeconomic and geopolitical uncertainty. For instance, the DAX (a German index), is up 16% YTD whilst the economy is expected to be in a recession in the next quarter. Contrast this with China, which is also going through a sharp slowdown and has corrected close to 10% this year. In the U.S., after a sharp correction in 2021, the magnificent seven – Amazon.com, Apple, Alphabet, Meta Platforms, Microsoft, Nvidia, and Tesla – have been on a tear, but the balance 493 stocks of the S&P 500 have risen by barely 5%.

Therefore, Indian investors creating or managing global portfolios must navigate this complexity by adopting a strategic approach. It starts with determining the optimal allocation to international assets (we recommend 10-15%), then the correct mix of asset classes, currencies, and geographies, and, finally, the periodic shifts between each of these based on the economic outlook. The last leg is known as tactical asset allocation. In the current environment, investors should consider the following factors in their tactical equity allocations.
 
The U.S. has the largest economy, the largest weight in global indices, and is a bellwether for global markets. Consequently, a significant allocation to the U.S. is warranted. Yet, tactically, we are underweight the U.S. given the burgeoning fiscal deficit, lower expected growth, and rich valuations.

China has the largest weight in emerging market indices. China slowed down sharply following the prohibitive lockdown in 2022. Excessive debt in their real estate industry and bankruptcies are adding to their woes. But market valuations are extremely cheap on a relative basis. Other emerging markets such as Indonesia and Vietnam have been exhibiting resilience. As a combination, emerging markets appear more attractive, and a tactical overweight could potentially serve investors well.
 
A less widely apparent tactical opportunity exists in Japanese equities albeit they too have had a good run recently. A change in the corporate governance of Japanese companies is the key driver. Further, while ultra-loose monetary policy has been hurting the Japanese Yen, some changes in policy stance could see it appreciate and provide an additional lift to USD investors.
 
In the past, investing internationally through the LRS was not easy for most people, and had only the big international banks provided the service. The advent of smaller platforms, including many fintechs, has made the process much easier and introduced a plethora of instrument choices, information, and even advice to investors.
 
Investing internationally can be extremely rewarding for domestic investors in terms of achieving better portfolio outcomes while expanding their knowledge and exposure. Given that we are likely to remain in a VUCA world (volatility, uncertainty, complexity, ambiguity), a systematic approach – sound strategic asset allocation and solid tactical choices – would hugely improve the odds of getting it right.

(Author is Founder & CEO of Sanctum Wealth)