Geographical diversification through ETFs can cut investment risks for retail players
Around the same time last year, the market was on a roll. It then appeared that nothing could possibly go wrong with the Indian market in 2018. But as crude oil prices, which were rising from the last quarter of 2017, started to get firmer and yields on 10-year US treasury bills inched up, realisation had set in on the Street that valuations are actually running far ahead of the schedule.
Suddenly, the operating environment had turned tough for India’s stock bulls. This time, unlike earlier, the Indian market was in splendid isolation, since the global markets, including emerging markets, were doing pretty well. Most striking was the rise in the US stock market, which scaled new heights on soaring FAANG stocks—acronym for best performing stocks of Facebook, Apple, Amazon, Netflix and Alphabet’s Google. As the US stocks rose, India, which was seen as one of the best places to invest in the preceding three years, turned into a market to be avoided overnight. Foreign institutional investors had been largely net sellers in the first nine months of 2018.
The remaining three months saw even the US market reverse the course, dragged down by the very same FAANG stocks. The point is, last year, the market had largely went against early-year expectations and predictions of the Street. That’s the challenge in equity investment. Unseen risks may crop up from any part of the globe and send all projections haywire.
When risks are unavoidable, the solution lies in diversifying investment to cut risks. Diversification does not solely mean investing in diverse sectors of domestic stocks. Perhaps, the time has come for Indian investors to think of geographical diversification of investment. The way the global economy is structured Indian investors are placed at a disadvantage if they follow only the domestic market.
Take a scenario of rising crude prices. When oil prices trend up, no segment of the Indian market would look attractive to invest. Even oil exploration companies don’t qualify then since they largely follow government diktat.
In such a set-up, ideally investors should own stocks from different parts of the world to gain from commodity cycles and geopolitical developments. But that is not possible for an Indian investor for many reasons. The next best option is to buy indices of different countries through exchange traded funds (ETFs) traded on Indian stock exchanges.
At this point of time, investors can look at two non-Indian indices; Hong Kong’s Hang Seng Index and New York’s Nasdaq 100 Index. These are the only foreign indices traded on Indian bourses. One wishes the Dow Jones Industrial Average or the FTSE were there. That would have given Indian investors wider options.
Hang Seng and Nasdaq are good enough for beginners, since they give exposure to two important segments of the global economy; the Chinese economy and the US technology space.
Since most Chinese companies are listed on the Hong Kong Stock Exchange and form part of the Hang Seng Index, this is an ideal route for an investor to take exposure to the Chinese economy. If the Chinese economy slows down, then Hang Seng too will go downhill. The latest example is of last Wednesday, when weaker Chinese manufacturing numbers were released, the Hang Seng slipped 2.71 per cent.
Similarly, the Nasdaq offers not only some of the best known technology and e-commerce companies of the world, but also future technologies that would dominate the world.
The icing on the cake is that these indices have been correcting in the last three months. The ongoing spat between the US and China are keeping Chinese stocks under pressure. But the situation is going to change, as both countries are suffering from the dispute and indications are that both sides are keen to find solutions. When a resolution comes about, Hang Seng would be a key beneficiary of the truce.
Moreover, MSCI is likely to increase the weightage of Chinese A stocks on its emerging market index. When that happens, the flows to Hong Kong would increase further, helping the Hang Seng.
Hang Seng can also be considered a play on the Chinese economy and global economic recovery.
Similarly, FAANG stocks have been correcting from November over multiple concerns, taking the Nasdaq down with them. The Apple outlook for slower sales is the latest addition to the FAANG woes.
A drawback of these ETFs is that they are not very liquid, so an investor may pay a high impact cost on these. But ETF is the only way to take exposure to some of the best global stocks.
Investors can start by taking a one-time exposure to these ETFs and then schedule a systematic investment plan (SIP) in these ETFs. Instead to having a monthly investment plan, it is better to have a quarterly investment plan. At this point, exposure to these ETFs should not be more than 10 per cent of one’s portfolio value. Over a period of three years, depending on experience, the exposure limit can be raised to 20 per cent.
As the Indian equity market develops further and ETFs gain in popularity, more international indices would be getting traded on the Indian stock exchanges. So, this is a good time for investors to think of investing in global indices.
(Rajiv Nagpal is consulting editor, Financial Chronicle)