Importance of diversifying your portfolio in global markets

Even though the short-term correlation across markets have gone up, over the long-term investments, the benefits of global equity diversification have not declined.

Importance of diversifying your portfolio in global markets
Rising inflation and aggressive monetary tightening by the US Federal Reserve have negative implications for the global equity markets.

By Raj Gandhi

The US, Europe, and Japan all have reported high inflation rates in the past weeks – the Russia-Ukraine war along with COVID-19 shutdowns in China is elevating the risks of a global recession.

India is not immune to global inflationary pressures and India’s retail inflation, as measured by the consumer price index (CPI), rose to a 17-month high of 6.95 per cent in March. Food prices are expected to remain elevated in the backdrop of supply chain problems as a fallout of the Russia-Ukraine war due to a disruption of global grain production, supply of edible oils, and fertilizer exports, according to the Ministry of Statistics and Program Implementation – transportation costs have risen due to rising fuel prices.

The Impact of Global Events on Indian Markets

Rising inflation and aggressive monetary tightening by the US Federal Reserve have negative implications for the global equity markets. The Nifty50 in the current calendar year has corrected by over 5 per cent, with volatility continuing in the months of May and June and observed in July.

Rising inflation and consequent monetary tightening impact the equity market through three main channels. It increases the cost of funds for corporations and therefore negatively impacts corporate margins. For policy rate tightening to be successful in bringing down inflation, it is essential that such measures reduce demand. This, in turn, implies lower corporate earnings.

An increase in interest and therefore the risk-free rate implies a higher discounting factor for future corporate earnings. This results in lower corporate valuation. As indicated earlier, the Indian equity market cannot remain unscathed as the global equity markets are correcting. Therefore, rising inflation and aggressive Fed tightening have negative implications for the Indian equity market as well.

How Diversification Can Help

The importance of diversifying one’s portfolio in global markets cannot be emphasized enough in current times. Diversification is a risk management strategy in which you invest in a variety of different financial assets, and which, in the event of significant market volatility, may reduce your chances of incurring major losses. The importance of diversification can be illustrated in the high inflation period happening at the very present. Even though the short-term correlations across market moves have gone up, for long-term investments, the benefits of global equity diversification have not declined. For Indian investors, stocks in developed markets are more stable than those in emerging markets. Developed markets and companies operating in sophisticated markets and stable political environments tend to be more heavily regulated and have stronger corporate governance structures.

(Author is Co-founder, DollarBull Fintech Platform empowering Indian investors with global investing solutions)

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