Are International Funds Worth Holding in This Volatile Market?
June 6, 2022 Mutual Fund
Whether you are new to investing or have been in the market for years, you may feel as if you are lost at sea, looking for a safe harbour due to the ongoing market volatility. The Indian equity markets have been witnessing volatility in tandem with the global markets for quite some time.
Investors are dealing with a slew of market forces, including high inflation, interest rate hikes, the Russia/Ukraine conflict, etc. At the same time, the conflict’s economic consequences will cause a considerable slowdown in global economic growth in 2022, as well as an increase in inflation. This is a troublesome combination of macroeconomic and geopolitical factors that have combined with a world still dealing with the effects of the pandemic, and this has an impacton both domestic and global markets.
Most Indian investors aim to benefit from having some global exposure to international investments via mutual funds. It allows them to invest in interesting and distinctive firms and industries that aren’t available on the Indian stock markets. The Indian markets, in addition, have a low correlation with several international markets, especially developed markets. This international allocation reduces portfolio volatility, diversifies the portfolio, and protects against rupee depreciation.
However, we are all aware that the global market is currently in a volatile state due to the current headwinds in play. The geopolitical and economic upheavals of recent months may have tested your resolve when it comes to your mutual fund investments, especially in international funds.
Higher interest rates takes a toll…
Recently, equity markets all over the world have been roiled. Global markets have experienced a sharp correction, led by the US, as the Federal Reserve begins its interest rate hike plan, leaving investors concerned about rising interest costs and inflation restricting growth after the pandemic.
Last week, the US Fed raised interest rates by half a percentage point to a range of 0.75% to 1%. With US inflation at 8.3% in April 2022, the highest level since the 1980s, more interest rate hikes are predicted.
In May 2022, the two leading US stock market indices, S&P 500 and Nasdaq 100 closed in red, posting a negative return of 0.56% and 3.32%, respectively. It has been one of the worst starts for the year, with Nasdaq 100 down by almost 23% from its December 2021 peak and S&P 500 down by nearly 13.3%.
Rising interest rates have caused a dramatic drop in technology stocks in the US, which has been a favourite among Indian investors for the past two years. Many Indian investors who have put money into overseas mutual funds that invest in US stocks, particularly technology stocks, have been affected by this. Any unexpected inflation rate changes may destabilise market sentiment and could send stocks further down.
The US is a key market that is home to several of the biggest names in the tech world. These companies benefited from the high rate of digitisation in the wake of the pandemic, which was reflected in their stock prices. But many of these shares fell almost as quickly as they rose.
With the Federal Reserve hiking rates, borrowing would become more expensive. In a high inflation scenario, a company is likely to incur higher costs to pay its employees, and other expenses would likely rise. Profit margins would be impacted by rising expenses, which could lead to a drop in the stock price. Although earnings growth in tech stocks was strong, the valuations of some tech stocks were stretched, and the prevailing rise in interest rates has pulled down such highly valued stocks.
The direction of global equity markets, along with movement in the dollar index and crude oil prices, will continue to dominate, while fluctuation in the inflation rate will also cause volatility in the market. Inflation is projected to stay high in the short term due to increased prices and supply chain disruptions. While market volatility is likely to persist, investors would be wise to invest in global markets over the long term and avoid making any knee-jerk reactions to the current scenario.
Should you continue with your investment in international funds?
Over the last few years, many individual investors have diversified their portfolios internationally, and now some international funds are experiencing a downturn. Investors saw technology services in demand during the pandemic. Investors took advantage of the easy money by speculating in technology stocks through mutual funds (by investing in international funds), especially in developed markets. But as interest rates rise and easy money dries up, the prices of these overvalued technology stocks and mutual funds focusing on them are falling. However, this does not mean you should liquidate your investments in international mutual funds in panic.
Global equity investments should be viewed through the lens of a long-term investing strategy. So, when some are not doing well, do not lose sight of the overall portfolio. All stocks and funds cannot do well at the same time. International funds add a layer of global diversification to your portfolio, benefiting investors in the event when domestic markets are volatile but global markets are performing well.
When interest rates rise, the markets are highly volatile at first but eventually recover. As the market becomes comfortable with higher interest rates, growth stocks in the technology sector may perform well. As per historical data, despite rising interest rates, tech stocks performed well in the period 2013-2017.
However, if you are worried about your existing investments in international funds, do not hit the panic button and rush for the exit. Figure out how much of your money is allocated to these funds. Reducing your exposure to international funds makes sense if your allocation is higher. If your international fund is underperforming owing to market volatility and is not a persistent underperformer, you may choose to continue with the globally diversified index/ETF funds.
Moreover, few savvy investors see the current global market situation as an opportunity to invest but cannot tap into it due to mutual funds being banned from investing in shares listed overseas. As mutual funds investing abroad breached the overall industry limit of USD 7 billion, fresh flows into these international funds have been put on hold from February 2022. However, there is a separate USD 1 billion limit for ETFs open, and some funds that invest in the Nasdaq 100 are open for investments.
As a result, feeder funds or Fund of Funds (FoFs) investing in international exchange-traded funds (ETFs) are still available for investment. If you invest in international ETFs, keep in mind that some of them may trade at a significant premium to their net asset value. Investors should also make sure that their investments in overseas funds are suitable for them based on their risk profile and investment horizon, rather than investing simply based on market hype.
Hence, investors must consider macroeconomic and geopolitical tensions in addition to rising interest rates when investing in overseas funds. Volatility may not disappear overnight, and it may put your patience to the test. To achieve a reasonable level of global diversification, allocate 5-10% of your overall mutual fund portfolio to international mutual funds. Focus on developed and emerging markets, such as the US and European markets, while investing in international funds, and opt for a passive index fund/ETF route.
If you are seeking to take exposure to any international funds or technology stocks and take advantage of global tech boom, ensure it does not exceed more than 10% of your entire equity mutual fund portfolio. Ideally, any international funds should not be part of your core mutual fund portfolio, and be held only to provide a level of global diversification to the portfolio.
Therefore, before you add any mutual fund scheme to your portfolio, ascertain your risk profile, investment objectives, financial goals, the time horizon in hand to achieve the goals, and asset allocation best suited for you. As a result, make sure that your investments are in worthy mutual fund schemes.
This article first appeared on PersonalFN here
