Do You Need International Exposure
India is a growth story. As a developing nation, we obsess over growth rates. While most analysts hope for a sustained 8% growth rate from India, our government has sometimes vowed to take India into double digit growth. I am not really sure if that is even possible. Nonetheless, every time the growth rate falls just below 7%, media and analysts make a huge deal about it worrying why the rate is so low. A developing nation is expected to have a high growth rate and so do a lot of investors. So, should one invest in international funds which have a slower growth rate?
Disclaimer: Information provided in this blog is to help educate you. Any mutual fund, company or stocks mentioned within the post are used only as examples, and should not be considered as recommendations or advice. Use the information to improve your knowledge, and make decisions based purely on your understanding. I may or may not have owned, or still own the names mentioned in this post at the time of writing. I am not your financial adviser, so you are liable for risks arising due to any financial decisions that you make based on methods discussed here.
First, lets run some numbers so have some understanding of what to expect. Entities such as OECD (Organisation for Economic Co-operation and Development), IMF (International Monetary Fund), WB (World Bank) and UN (United Nations) have all come up with some forecasts for India's growth rate for up to 5 years into the future. Their forecast falls in the range of 7.4% to 7.7%. Lets assume an average real GDP rate of 7.5%. Now, RBI is trying to keep the inflation rate to around 4%. So the nominal GDP growth rate comes to 11.5% (7.5% + 4%). If you were to invest in India's growth story, we can expect a return of 12% to 13% including dividends. Can international fund's return exceed that number?
When we talk about international funds, we generally talk about Western Europe or US given that their financial statements are in English and those countries have a long history of corporate governance. In this example, I just want to learn a thing or two using US stock market as my international exposure. Remember that when investing in international funds, you run the risk of forex. I ran some numbers using US and Indian stock market from 2008 to 2018. The idea is that you would invest a lumpsum amount in 2008 in both S&P 500 and BSE S&P 500 and check the returns as of end of 2018. This is what I found out --
From 2008 to 2018
S&P 500 returns: 10.32%
Change in exchange rate: 3.7%
Nominal rate of return from US market: 14.39%
BSE S&P 500 returns: 14.59%
As we can see, the US stock market has grown only 10.32% during the 10 year period, but because of the change in exchange rate at 3.7%, we would have made a 14.39% nominal rate of return. However, if you had invested the same amount in BSE S&P 500, you would have made a slightly better 14.59% return. In this case, it does not seem like having an international exposure is neither good or bad.
Next, I experimented with an even longer duration, from 1998 to 2018. Let the numbers speak for themselves --
From 1998 to 2018
S&P 500 returns: 3.39%
Change in exchange rate: 2.45%
Nominal rate of return from US market: 5.93%
BSE S&P 500 returns: 14.86%
Now it seems like having an international exposure did not seem to benefit us at all! We would have made a cool 14.86% return in Indian equities vs a meagre 5.93% on US markets. So the moral of the story is that timing the market seems to have some weight to it.
Now, do I think it is worth investing in International markets? Yes it is, with a caveat, which is that you should not be the person who is timing the markets or evaluating whether Indian market is better or international markets are better at any given time. What I mean by that is that own a fund where the fund manager is doing the work. An example of such a fund is Parag Parikh Long Term Equity Fund, with a mandate that allows the fund to have up to 35% exposure to international markets.
Alternatively, if you really want to have international exposure, have 25% of your equity investment in stable international markets, such as the US market. You can find a ton of such funds. An example would be Motilal Oswal NASDAQ 100. Don't go overboard and invest in some global real estate fund :) . The whole point of investing in international funds is to diversify and reduce the volatility. Also remember to find funds with low expense ratio (such as ETFs) when investing in international funds, since their returns will be lower compared to Indian stock market.
Finally, you might stand to benefit from some expert talk on investing in international funds in the following Value Research episode.
Update on March 03, 2019
I realized that I did not mention anything about taxation of international funds, so here is a quick update on it. If you are holding international stocks or mutual funds with more than 35% in international holdings, then you are subject to a different tax on capital gains. As of 2019, if you hold Indian equities and equity mutual funds for less than 12 months, then the short term capital gain tax is 15% without indexation. If you hold them for more than 12 months then the capital gains tax is 10% without indexation (after a 1 lakh exemption limit). If you hold international stocks or funds for less than 24 months, then the gains are added to your income and taxed at the income tax slab applicable for your income. If you hold them for more than 24 months, you pay a 20% tax with indexation benefit on the capital gains.
Update: After reading the comments, I have added the following section.
Disclosure: I did not invest in international funds until after 2013 when I first started investing in Parag Parikh Long Term Equity Fund (not a recommendation, just a disclosure) which has an exposure to international stocks. That is the only international fund I invested in. From their latest factsheet, they have a 28% international exposure. I have 23% of my retirement corpus invested in that fund. That brings my total international exposure to around 6.5%. Note that my retirement corpus is different from my vacation corpus. I have a few US shares of one company by the way of stocks that vested during my employment. That corpus is earmarked for any international vacations that I might take. That does not come under the 6.5% exposure mentioned above.
I don't consider my vacation corpus as part of my investment. I left some company shares there because I already achieved my retirement goal. I sold most of my US stock around August 2013 and invested in Indian market when the Indian stock markets was getting a severe beating while my company stocks were doing fine. Post that, I sold a few of my company stock here and there and added to my retirement corpus until it matched my goals. Now whatever is left over in the US is like a windfall and I want to use it for vacations. Don't plan to sell them in the near future since I have confidence in the stock and also I don't have any good deployment ideas if I sold them.