Is It Worthwhile Adding International Mutual Funds to an Investment Portfolio?

June 30, 2023 Mutual Fund

The World Bank, in its recent global growth outlook on June 06, 2023, said India would remain the fastest-growing economy in terms of both aggregate and per capita gross domestic product (GDP) among the largest emerging market and developing economies. India’s economic growth in the current financial year appears to be resilient; it is expected to thrive at around 6.5%, despite risks emerging from a global slowdown.

Now, the global economy has been witnessing sluggish growth this year, what’s affecting the major global economies’ recovery process are the high interest rates, the repercussions of Russia’s invasion of Ukraine, and the lingering effects of the pandemic. In order to counteract a return of inflation, the Federal Reserve and other major central banks have been rapidly hiking interest rates. This rise in inflation was sparked by a stronger-than-anticipated rebound from the pandemic recession, ongoing supply issues and spikes in gasoline and food prices caused by the Ukraine war.

However, the global economy has recently proved to be surprisingly resilient in the face of higher borrowing costs. In its latest Global Economic Prospects report, the World Bank marks an upgrade from its previous forecast in January 2023. The report forecasting the global growth mentioned, Real global GDP is set to climb 2.1% this year, which is up from a 1.7% forecast issued in January 2023 but well below the 2022 growth rate of 3.1%.

Data as of June 28, 2023
(Source: www.IMF.org) 

The United States of America, China, Japan, Germany, and India are the largest economies in the world in 2023, as per their current GDP data. The Global GDP was slowing to the brink of recession, but since then, strength in the labour market and consumption in the U.S. has exceeded expectations, along with China’s recovery from COVID-19 lockdowns. As per the World Bank’s Report U.S. growth for 2023 is now forecast at 1.1%, more than double the 0.5% forecast in January, while China’s growth is expected to climb to 5.6%, compared to a 4.3% forecast in January 2023 after COVID-reduced growth of 3% in 2022. The euro zone got a forecast increase to 0.4% growth for 2023 from a flat outlook in January, but the forecast for next year was also cut slightly. This indicates that the macroeconomic outlook for the world looks positive in the long run, but there are headwinds in play.

Given that, when managing one’s investment portfolio, most Indian investors aim to benefit from global exposure to international investments via mutual funds.

Let us find out where do the valuations of the Indian equity market stand relative to its global peers. And whether one should add international funds to their portfolio under the current scenario…

You see, along with being one of the world’s largest economies, India is also considered one of the top investment destinations by several foreign investors. However, one of the factors that is holding them back from going all out into Indian equities is expensive valuations.

India’s equity market valuations are higher compared to most global peers trading at lower values. The Price-to-Earnings (PE) Ratio is a popular measure to compute valuations of the benchmark.

Table 1: Price-Value Comparison of Major Global Indices

Data as of June 28, 2023
(Source: Index Website Database) 

According to Bloomberg estimates, the Nifty 50 1-year forward P/E Ratio is at 19.86 times, making it the fourth most expensive market among global peers and the most expensive emerging market. However, the valuations do not seem to be in the bubble zone either. This means India’s valuations are not cheap but are neither extremely expensive. However, they have still not fallen to levels that give investors comfort to put money aggressively.

Going forward, do note that the possibility of global recession, rising inflation, an uncertain outlook, and geopolitical tensions are likely to impact the Indian equities market. If the economic growth does not sustain as expected, it can lead to sharp corrections in the market. Thus, it would be better to consider a well-diversified mutual fund portfolio and not skew it too much to domestic equities swayed by recent market highs.

[Read: Indian Equities Near a Lifetime High! Why Investing in Multi-Asset Funds Now Makes Sense]

Why Add International Funds to Your Portfolio?

The market value of India is approximately $3.31 trillion as per May 2023 data. India has restored its ranking as the fifth-largest market in the world following a widespread surge in domestic equities. This comes after briefly losing the spot to France in January 2023. This improvement in position might be attributed to the robust performance of the Indian stock market.

Table 2: India Ranks 5th in the World Market

Data as of May 31, 2023
(Source: Bloomberg) 

Even though India is now among the top five nations in terms of market capitalisation, it only accounts for 3-4% of the total market capitalisation worldwide. Given this low share, you could diversify a small portion of your equity portfolios into international funds taking into account the suitability of each investor. Given that the globe is undergoing seismic transitions with shifting capabilities, while our domestic economy may occasionally struggle a bit, other economies may perform well. Thus from geographical diversification standpoint a small exposure to international funds may make sense.

The Indian markets also have a low correlation with several international markets, especially developed ones. 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 given headwinds in play.

Domestic Equity Funds vs International Funds

While International Funds offer several advantages, domestic funds are no less. There are several equity-oriented mutual funds that have delivered significant returns across timeframes. Therefore, one should invest in domestic funds first and once you have devised our financial plan you may start allocating to overseas funds.

Global equity investments should be viewed through the lens of a long-term investing strategy. International funds add a layer of global diversification to the investment portfolio, benefiting investors in the event when domestic markets are volatile but global markets are performing well.

Table 3: Returns Clocked by International Funds

*Past performance is not an indicator of future returns
Data as of June 29, 2023
(Source: ACE MF) 

Given the uptick in funds with investments in the U.S. economy, particularly in U.S. technology, returns from overseas funds are positive. There may be an opportunity for investors to acquire particular high-quality stocks at affordable prices, especially on the strength of excellent fundamentals, since international equities, such as those in the S&P 500 index, are selling near to or below the average medium-term P/E. Furthermore, listed Indian companies have a smaller presence in emerging industries like Artificical Intelligence (AI).

As a result, under the current macroeconomic scenario, investors holding adequate domestic investments may consider allocating a small portion of their overall portfolio to international mutual funds to diversify their assets in these developed and emerging markets.

Who Should Invest in International Funds?

Investing in international mutual funds from India is similar to investing in domestic mutual funds, with the exception that the funds are held in equities of foreign corporations that are listed abroad. Fund managers achieve this by making investments in both global indices and ETFs. Passive funds can be helpful for building an international portfolio since they are less expensive and more tax-efficient than active funds. Additionally, there is no risk of stock selection bias since, the passive management requires less fund manager intervention.

A long-term perspective while investing in International Funds is helpful since it takes time just like any equity mutual fund to deliver meaningful results. Only investors with a high-risk appetite who could stomach the international market risks, currency risks, any geopolitical fluctuations, etc., may consider investing in such international funds. Additionally, one should have a long investment horizon to overcome the short-term volatility that may occur and ensure that your investment objectives align with the fund.

This article first appeared on PersonalFN here