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Indian investors should add foreign stocks to their investment portfolios

There are many ways to invest in global equities: Mutual funds investing in global equities and ETFs listed on Indian exchanges investing in global indices.

Last Updated: Jul 09, 2018, 06.30 AM IST
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It is the same as investing in Indian equity except for the tax treatment.
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By Mayank Joshipura

Stock investors seeking to diversify their portfolios often look within the asset class, spreading their investments across large-, mid- and small cap stocks. They rarely see global equities as a diversification opportunity because they believe Indian stocks will deliver superior performance over other markets. The huge FII investments in Indian equities over the years is used to justify the Indian equity out-performance story.

It’s high time to shatter this myth. We looked at the performance of Indian markets versus the US markets for the past 27 years and found that the US markets have outperformed the domestic market both in absolute as well as riskadjusted terms. While the Dollex 30 has returned 8.6%, the Dow Jones Industrial Average (DJIA) has given 8.65% (see table).

The higher absolute returns from the US markets were surprising, especially because the study looks at data from 1990 to ensure that the fruits of India’s reform story were not ignored. The Dollex 30 measures the dollar returns of the Sensex for global investors after controlling for currency fluctuations.

But there are more surprises in store. Both DJIA and Dollex 30 don’t include dividend yield. DJIA’s dividend yield is more than twice of the Sensex. So, when we look at total returns, the outperformance by the DJIA is massive. Besides, the Indian markets are two and a half times more volatile than US markets. The reward-to-risk ratio for DJIA is 0.58 compared to 0.24 for Dollex-30.

Also, look at the difference between oneyear maximum returns for Dollex-30 and DJIA. It is 87.73% for Dollex-30 compared to 33.45% for DJIA. Such positive skewness in returns attracts investors towards Indian markets. So assuming an investor has a great sense of moving in and out of the markets at right time, Indian equity markets markets present a great opportunity. If not, then the fact remains that $100 invested in both Dollex-30, and DJIA at the end of 2007 were worth $72.44 and $78.61 at the end of 2009 respectively. This is despite stellar performance of Indian markets in 2009. It doesn’t matter, illusion of timing skills and love for lotteries is pervasive and global investors are not an exception to it. So you will keep on seeing global money chasing the Indian equity markets for diversification and in search of rare exceptional returns. Does that mean we should prefer global equities over Indian equities? Not exactly. Every coin has two sides. And there are several advantages of investing in Indian equities as well.

Will Indian equities underperform?
While our study shows how US equities did better than Indian markets, this may not hold true for all periods. There were times Indian equities did better than US equities and vice versa. So it’s not about substituting one versus the other. That means adding US equities can provide stability to your equity portfolio without sacrificing returns. In fact, investing in global equities allows an Indian investor to participate in growth stories of economies other than India.

US markets outperformed Indian stocks
The DJIA has given higher returns than the Sensex since 1990.
ET Bureau

However, the US market’s outperformance over Indian market does not mean that the same is true for other global markets. So, one needs to beware of landmines while investing in other global equity markets.

Our analysis compares two large-cap flagship indices from India and US. It is possible for an avid stock picker to generate superior returns in Indian markets beyond large-cap universe as there is an information advantage in analysing domestic equities than global equities.

The taxation disadvantage
There are many ways to invest in global equities: Mutual funds investing in global equities and ETFs listed on Indian exchanges investing in global indices. It is the same as investing in Indian equity except for the tax treatment.

Before the re-introduction of LTCG tax from 1 April 2018, investing in global equities had disadvantages from the taxation point of view. But that is not the case anymore. Investors in domestic stocks, who earn more than `1 lakh LTCG in a financial year, will also have to pay 10% tax now. The STCG tax on Indian equity and equity mutual funds is 15% without indexation if held for less than 12 months.

On the other hand, international funds and ETFs are taxed like debt funds—20% LTCG tax with indexation benefits for a more than 36 months holding period. The LTCG tax can be higher or lower depending on inflation and level of returns due to indexation benefits available with global funds and ETFs. Another way to invest in global equities is to buy Apple and Alphabet or to invest in ETFs listed on global exchanges. Here the tax treatment for LTCG is different. On the sale of such investments, one has to pay LTCG tax of 20% flat without any indexation benefits. So, yes, if you choose this route of investing in global equities, you may end up paying the higher tax. Of course, the annual cap of $ 250,000 applies while investing through this route. The short-term capital gains tax is higher in case of global equities than in domestic equities for an investor in the highest tax bracket. The same is true for dividends.

The best performing international funds
But the returns from these global funds can vary quite a lot.
ET Bureau
Source: Value Research

Currency exposure and risk
Investment in global equities exposes an investor to exchange rate fluctuations as well. And one has to be careful before investing in equities with unstable and volatile currency. Going by history, an investor investing in US equities have seen their returns boosted by the depreciation of rupee over the years. And since India is likely to remain a higher inflation economy compared to the US, we don’t see the trend changing soon.

(The author is professor & chairperson (finance) at the School of Business Management, NMIMS, Mumbai. The views are personal.)

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(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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