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US Market | SIP: Put a SIP in US markets; don’t worry about valuation & let time be your best friend: Kaustubh Belapurkar

Kaustubh Belapurkar, Director – Fund Research, Morningstar Investment Adviser India, says benefits of diversification in the US market remain a very compelling choice. Tax has changed and there is nothing that we can really do about it and my advice to investors would clearly be that go on the merits of the product, not necessarily, what the taxation is because we have seen that tax laws can change at any point of time.

The merit of the product should be the predominant deciding factor. There are enough merits to make an investment in US equities. One needs to be invested in those markets to make the most of it when the run up happens again and that is where you can really aid in diversifying your portfolio, not just typically by set class or by market capitalisation, but by geography of the businesses that one is investing in.

How exactly are the US equity market placed?
We are having this conversation at a very good juncture. We have been very strong proponents of international diversification. Let me quickly address your question about where the US market is placed. There have obviously been headwinds for the US markets, given where the economy is headed with inflation concerns and the Fed hiking aggressively.

But what we have seen in the past one year is that in 2022, especially CY22, there was a sharp drop in the US equity markets and the Indian equity markets relatively outperformed. In the first three months of 2023, there has been a recovery in the US markets, especially in the technology sector and some of the communication, media, entertainment names; but that valuation gap still exists.

So, broadly, the US markets are poised at a very interesting juncture. There are clearly some headwinds in the short term, but the overall thesis when we think about investing in a market like the US, that still remains intact over the long term.

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Also, when we talk about international exposure to your portfolio or maybe diversification of that type, why should we consider only US markets at the current juncture?
I would not say it is a case only for the US markets. But when you think about the options that are available to an Indian investor right now, especially through India domicile fund route, a majority of them are sort of US-based, that is one. Secondly, the US markets being the world’s largest economy and being home to some of the largest corporations, global corporations, the most innovative corporations around, definitely makes a compelling case to have allocations towards US equities. One can definitely look at other markets across the globe, but an Indian equity investor should be looking to allocate some of his or her capital towards US markets from a long-term perspective,

Let me outline some of the reasons that I kind of alluded to. Some of the largest corporations in the world reside in the US and remember that these are corporations that do not have business only in the US and have businesses all across the globe. I will give you some quick stats. When you look at the large benchmark indices, be it the Nasdaq 100 or the S&P 500, only about 50 odd percent of the total revenue of the Nasdaq 100 companies actually comes from the US.

The rest comes from outside of the US and so truly global even in their revenue spread. You are getting exposure to a corporation that has revenues coming from all across the globe. In fact, India accounts for about 1.5% of the overall sort of revenue coming in for the Nasdaq 100 companies. Similar stats for the S&P 500, probably slightly more US centric given the spread of the companies that are available, about 60 odd percent comes from US revenues and the remaining 40 comes from outside and about 1.5% again coming from India.

These are all brands and companies of which products and services we are very well acquainted with, so why not participate in the growth of these companies which are really cutting edge in terms of the innovation and coming with products and services which an Indian investor otherwise would not have access to necessarily from a local market context? That adds a lot of value to the portfolio.

We speak about diversification, here is a diversification that can happen in terms of company type, product type, obviously geographical diversification because the other thing that has played out in the past if you just look at calendar year returns of say Indian equities versus US equities and some of the other international markets, they always work in tandem.

2022 was a classic case in point where Indian equities did relatively much better than US equities. But if I just take it back in time to 2019, 2020, 2021, especially 2019 and 2020, US equities significantly outperformed Indian equities. So, one needs to be invested in those markets to make the most of it when the run up happens again and that is where you can really aid in diversifying your portfolio, not just typically by set class or by market capitalisation, but by geography of the businesses that one is investing in.

Should this diversification be broad-based or can we also take a thematic route when it comes to international exposure and specifically US equities?
I would lean towards a more broad-based diversification. For most investors, that would probably be the ideal route. Typically more broader indices would have a good representation of the largest companies, which are US domiciled, but have operations all across the globe.

There are two primary indices that people track. Obviously, there is that Nasdaq 100 which is typically more overweight towards sort of the technology, communication services names. It does not have any financial exposure or the S&P 500, which also includes financial exposure within the two broad US indices that investors can look at and obviously, there are options available to them across both of these.

Thematics would only be useful for investors who want to express a certain view and who are very positive say on a certain set of stocks or is more pro-value or growth and who want to do a style-based diversification and are ready to expose themselves to that. Otherwise, a broad-based outlook works best for most investors.

How can one capitalise on the currency hedge here?
Remember, when you are investing in a fund, it may be rupee denominated, but the end investment that the fund is making is either into US stocks or a US-based ETF or a fund which is obviously US denominated. So your end investment is US dollar denominated and given that traditionally we have been a high growth, high inflationary economy with higher interest rates, the rupee has depreciated against the US dollar and as US inflation and interest rates normalise over the years, the rupee could continue to depreciate versus the US dollar.

That will essentially allow you to take a US dollar exposure which could also help you get some currency appreciation. While that is not the primary motive, a lot of people for instance have goals for their children to say study overseas and we have all faced the brunt of it as costs of education are going up. Now, with a depreciating rupee, the cost of education gets exacerbated even more. Here is an investment where not only will it benefit from the fundamentals of the US economy, but perhaps the rupee depreciation could play out over the coming years.

In a globalised world, economies are connected with each other. So, when we talk about international diversification, is it really diversification in its true sense and for that matter, US equities?
Yes, absolutely. We always imagine that we have one global pool of assets and that is how economies are definitely going to be kind of not necessarily moving in tandem but taking a cue from each other, but markets always can move in dissonance and that is actually what we have seen in the past and we expect that to continue to play out.

Coming to the calendar year returns of the broader Indian indices versus the two frontline US indices, we have seen that 2019 and 2020 were great years for the US markets versus the Indian markets. In fact, 2020 is a specific case in point where the tech stocks did exceedingly well. The Nasdaq 100 was almost up 50% versus maybe about 16% to 20% for the Indian indices. The S&P 500, probably not so much and was only up about 18-20%.

But in 2019, both of these indices were up between 30% and 40%, whereas the local markets were only up 10-12%. We know that had changed in 2022. We have seen this in the past also. Let me take you back 10 years. 2013 was another classic case in point where the dispersion of returns was massive between the Indian markets and the US markets. In the US markets, both these indices were 30% plus for CY2013, whereas the local Indian markets were up about 6% to 7%. This completely flipped in 2014, where post the election results, the Indian markets ran up. While the US market posted reasonable returns of high teens, the Indian markets were about 35-40% up. This interplay of market movement continues to happen obviously depending on where people see valuations for markets relatively undervalued can move up.

That aids in diversification if you are buying asset classes which on a long-term basis could potentially be correlated, but the short-term movements can help pad returns and give lesser volatility on overall portfolio construct, if one equity asset class is not moving. The other is relatively doing better.

Coming to the US vulnerability of recession, why invest in such an economy after all? Do you think the valuations are really right looking at the risk, which is still ongoing? What kind of exposure to start off with one can have and maybe increase it later on as the risk fades?
I think, let me address this through a couple of pointers. One is, there are some short-term pains with regards to the US economy. Obviously, there is the looming recession that could potentially come, the inflation that they have not seen for so many decades. Obviously the Fed has been aggressive in their rate hikes. The oil prices are moving upwards, given the Opec production cut, which could also have an overhang on the inflation.

All of these short-term problems do exist with the economy, which could potentially be an overhang in the short term. But, just going back to my earlier point about, when we think about the US markets, while there could be companies that are operating out of the US, these are truly global businesses.

If you are looking at the Nasdaq 100, only 50% of the revenues are actually coming from the US, and the remaining from outside geographies. You are getting exposure to companies, which otherwise you would not necessarily have exposure to, from an Indian perspective.

We are all users of this so for instance, if you are using a computer, you are either on a Windows computer or a MacBook, and these are two of the largest listed corporations on the US indices. We all use Google, we all use Facebook, there are a lot of us using Netflix. These are all corporations that while present in the US have a lot of operations or revenues coming from outside. In that sense, to a large extent, they are not completely dependent only on the US economy to drive their revenues. That is a very important thing to keep in mind.

The exposure that you are getting to this economy, which otherwise, would not be available to you necessarily from an Indian context. Obviously we talk about valuations, and like we said that US stocks or the markets have been in the undervalued zone for the last six, nine months, since the large part of 2022, because of the steep correction that happened in the markets, especially on the tech stocks in the year of 2022.

Some of this undervaluation has gone away simply because there has been a reasonable run up in these stocks in the past three months. But I would not think of that only as the trigger to move in because I think timing can be fraught with a lot of timing risks in terms of trying to just chase valuations and come in.

The compelling argument is buying these businesses, buying the diversification benefits and getting exposure to companies that you cannot otherwise get. That is the best route for any investor. We always recommend it, come in systematically. I know there are challenges in terms of which funds are open, which are not and that is something investors will need to figure out from their advisors. But definitely come in systematically and probably add about 10% of your equity portfolio to international funds. I would say a large part through US funds would definitely add great diversification and return benefits over the long term to your portfolio.

What about the choice of index? S&P 500 and Nasdaq 100 clearly have the largest corporates in the nation and also have a fair, strong value proposition here. But then there are other choices of indices as well. How can one decide?
Just try to think about where you want to be leaning towards your exposure and there is no right or wrong answer, to be honest because these are two very, very broad and well-tracked indices. I would actually be indifferent between both of them, the Nasdaq 100 and the S&P. Obviously, we must acknowledge that Nasdaq is tech heavy. The top five would account for more than 40%. So it is a little kind of concentrated in that sense.

For Indians to invest in the US markets, should there be direct investment strategies or should one be going through AMCs and also through funds and the SIP route? Which is safer?
Yes, I would definitely do an SIP through the funds that we have domiciled in India. It is the cleanest and the easiest way of doing it. Obviously, the other option is doing the LRS which is a very operationally hassling tool. It is subject to which fund they are open right now, given the caps that are in place. I am given to understand quite a few of these are currently open. So investors can evaluate which exposure they want to take and then definitely do an SIP in those funds.

The funds returns for last one year look really negative. But the returns before that make them hard to ignore. So what should be the placement? How much should be the exposure? Suppose a fund is supposed to be entering this market through maybe a fund of funds or an ETF, what should be the exposure like in the portfolio?
I would say, maybe about 10% of your overall equity exposure. You want to add and do that systematically. The near term returns have not been great and that is probably the right time to get in. Like there was a significant run up in US stocks in 2013. A lot of money came into US funds in 2014 after the run up had already happened. And then people went overboard, invested a lot of money into US funds and that is when the tide turned. and the Indian equity started doing well.

We want to avoid chasing recent performance, rather just systematically decide to invest an X%, which is typically 10%, for your portfolio. Put that SIP in place in the US markets. Do not worry so much that the valuation is in the fair zone or slightly overvalued or undervalued. Let time be the best friend for you in markets like this.

Despite the shifting tax landscape, how attractive are international funds even now? What does one need to take care of?
The diversification benefits still remain a very compelling choice. Tax has changed and there is nothing that we can really do about it and my advice to investors would clearly be that go on the merits of the product, not necessarily, what the taxation is because we have seen that tax laws can change at any point of time. So we shouldn’t really be basing our decision purely on what the taxation is.

Obviously, it does weigh on your decision, but the merit of the product would be the predominant deciding factor. And then definitely like I outlined in the discussion, there are enough merits to make an investment in US equities.

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