India is booming. But you still need international exposure

You see, what’s happening here is that the lay investor is thinking macro. India will do well, so stocks will do well. Period.

What Devina, a seasoned investor, is perhaps thinking (my guess) is that she needs to own the best investment opportunities, irrespective of what they are, and where they are domiciled. And then she is perhaps ensuring that they fit in well with her asset allocation. At least that’s what it appears from the chart alongside the Mint article. She owns, stocks across the world, REITs, commodities, and debt. Yeah, debt, and that too with a 17% allocation.

If investing globally or thinking from an asset allocation perspective did not shock you, perhaps the allocation to debt did!

Now that I have your full attention, in this edition of Contramoney, we will focus on why one needs to think global when investing money. I offer three reasons—depreciation, diversification, and disruption.

Let’s start with depreciation of the rupee vis-à-vis the US dollar. This is a 50-year chart showing that the Indian rupee has consistently lost value in comparison to the dollar.

If one were to focus just on recent times (five years), well, the situation is no different.

Now, this is not to say this trend will always persist. Predicting exchange rates is tougher than understanding rocket science!

But what we can safely say is that over a long period of time, there’s a fair chance that the rupee will come out as a weaker currency. So, every rupee you own will buy you fewer goods and services in dollar terms. Conversely, every US dollar you own will buy you more goods and services in India; all else remaining the same.

And this is what makes the case for investing some money in the international markets. Let’s understand this using a simple example.

Suppose you had ₹8,330 (equivalent to $100, at ₹83.3 per US dollar) to invest.

If you invested in India and assumed a 15% CAGR over five years, your investment would have grown to ₹16,755.

Now, let’s assume that the international investment also delivered a similar return. The value of your investment would have grown to $201.

What we now need to factor in is the depreciation in the value of the India rupee. Let’s stick to the 5-year average of 3.6% per annum. The value of the dollar at the end of five years would have grown to ₹99.5 per US dollar. As a result, the rupee investment value at the end of five years would be ₹20,023. That 19.5% more than what you’d have made in profits if you had invested in India.

Before you start jumping with joy, or anguish, understand that I have grossly oversimplified the situation to show you the impact of a depreciating rupee, or conversely, the advantage of investing in a US dollar-denominated stock market. Again, these are assumptions, which can and do go wrong from time to time. What we do know is that if history repeats, then a scenario like this is also a possibility.

Also, there are other ways to guard against depreciation. For instance, there’s gold. But we will go into the lustre of gold in more detail in subsequent issues of Contramoney.

For now, let’s talk about diversification. We have always said, “Be super bullish on India, but cautiously optimistic on Indian stocks". This is a strategy with a high probability of success. But when you are thinking long-term wealth, the question to ask is, what if something were to go wrong?

I think the classic example here is China, which had everything going for it. But then, there was a pivot, and things went awry as one can see in this chart below. This is the Shanghai Composite Index over a 30+ year period.

Sure, we can blame it on politics. Or, if you are looking for harder indicators, look towards the real estate sector. India had a similar misstep in the 2000s, and the repercussions of that (reflected in huge non-performing assets) lasted years.

So, while I am not alluding to this or any specific crisis, what I am saying is, there’s always a chance something happening, however small it may be. Diversifying your assets across the world sensibly, can lower this risk, while at the same time ensuring that you do not miss out on the returns.

This brings me to the third point—disruption. Anything and everything that we read, watch, and increasingly interact with, has a component of artificial intelligence (AI). Recently, I read The Coming Wave, by Mustafa Suleyman, co-founder of DeepMind. It’s a nice read, peppered with some hard-hitting facts and developments. Suleyman talks at length about how the world is changing, particularly in the context of—Artificial Intelligence, Robotics, Synthetic Biology and Quantum Computing.

Each of these spaces have the potential of disrupting our lives, in one way or another; good or bad. While our points of views might not converge on that thought, here’s one thing we could agree on. Maybe there’s no one high conviction investment opportunity in India that you and I can bet on to participate in any of these four themes! For an investor building a portfolio purely in India, well, that’s just disappointing.

I mention these four trends as an example. There are so many other opportunities that are difficult to tap into via Indian companies, but one can easily do so internationally.

These three reasons should be convincing enough for anyone to at least start to think about global diversification. And remember that’s just a start.

Once you decide to actually venture out, there’s a whole lot of work to be done. First, decide how much you want to allocate internationally. Here, you can also factor in if you have any planned foreign currency denominated expenditures coming up. Like university fee for your kids. Or second, whether you want to go for individual stocks, or index funds, or actively managed funds. Or perhaps a mixture of all three. And third, decide the platform you want to use to make these investments. And there’s even more beyond this, including taxation.

I mention this to alert you that investing is simple, but never easy. You still need to follow a disciplined approach and put in the hard work.

In conclusion, sensibly done, global exposure in your asset allocation should be a big plus. And it could be worth the time and effort you put into getting it in place.

 

Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477.

You should always consult your personal investment advisor/wealth manager before making any decisions.