Maintain exposure to US funds in face of recent underperformance

Your portfolio will benefit from geographical diversification

Over the past one year, actively managed US-focused funds have given a return of -6.3 per cent. In comparison, the Sensex has been flat. Despite the pain investors have experienced in the recent past, they should hold on to these funds.

 

What went wrong?
 

Low interest rates and high liquidity injected to cope with the Covid-19-induced slowdown provided tailwinds to the stock market in 2021. However, the scenario changed once inflation came to bite the economy and the US Federal Reserve (Fed) decided to raise interest rates.
 

“Persistent, sticky inflation, supply shortages, and Fed rate hikes to control inflation have created anxiety among investors. The US tech sector has been hit the hardest. Typically, when interest rates rise, PE (price-to-earnings) ratios within growth sectors shrink. In addition, declining growth leads to contraction in earnings, thus dealing a double whammy to stock prices,” says Anup Bansal, chief business officer, Scripbox.
 

Adds S Sridharan, founder and principal officer, Wealth Ladder Direct: “Restrictions imposed by the Reserve Bank of India (RBI) on overseas investments by mutual funds meant investors were not able to average out their investments during the downturn. This added further unpredictability to their returns.” 
 

Uncertainty persists
 

Most experts expect the Fed to continue raising interest rates for some time. Even if it decides to pause, or cuts rates to combat a possible recession, there is no assurance that corporate earnings of US stocks will improve anytime soon.
 

“There is a lot of uncertainty around growth, inflation, rate hikes, geopolitical situation, and the pandemic. All these could have a considerable impact on investments. If there is a mild recession in the US, it is likely to produce a mild correction in the US market,” says Bansal.
 

Stay diversified
 

Exposure to US equities provides geographical diversification to portfolios of Indian investors. Moreover, many themes and businesses that are available in the US market are not available on the Indian exchanges. Among all developed markets, the US is the best in terms of disclosures, transparency and corporate governance.
 

“Once they have significant exposure to domestic stocks, Indian investors must consider diversifying by investing in international funds. And this is best achieved by investing in a market such as the US that has a low correlation with the Indian market,” says Niranjan Avasthi, head-product, marketing and digital business, Edelweiss Mutual Fund.
 

What should you do?
 

Just as chasing US funds in search of high returns towards the end of 2021 was a bad idea, shunning them now because they have had a bad year in 2022 would also not be wise.
 

Investors must maintain their exposure to US equities. “Prices of US stocks, particularly technology stocks, have become more reasonable. Hence, this is a good opportunity to start investing in these funds. As the Fed interest rate hike cycle ends, US stocks may witness a resurgence,” adds Avasthi.

Build the exposure to overseas equities gradually via the systematic investment plan (SIP) route. “Investors who have financial assets of over Rs 10 lakh and whose risk-appetite ranges between moderate and aggressive can allocate 5-15 per cent to US-focused funds,” says Bansal.
 

The passive path
 

Besides active funds, a variety of passive options for the US market have also become available. Since active funds in the US have a poor track record of beating their benchmarks, investing in passive funds in that market makes sense. In view of the recent volatility, investors should avoid funds based on narrowly focused indices.
 

“Invest in the S&P 500 for exposure to the broader market and in the Nasdaq for exposure to the top tech and research companies,” says Bansal. Sridharan, too, is of the view that investors with high-risk appetite. and a horizon of 7-10 years should invest in US-focused passive funds.