Why should I invest in the US markets?
US equities give diversification and exposure to global growth in the most stable currency. Invest in US equities, if you can find a cost-effective way to do it.
As an Indian equity investor, there are plenty of reasons for you to invest in the US equity markets. Equally, there are good reasons why one should avoid investing in US markets, if they are already exposed to Indian equity.
Diversification is an important part of an investment journey. It helps one reduce volatility and risk of their portfolio, especially at larger portfolio sizes.
As portfolios get bigger over time, drawdowns can also be larger in absolute terms. When your portfolio has ~₹100,000 (1L) in valuation, a 1% drop is a nominal loss of ₹1,000. At ₹1,00,00,000 (1 Cr.), same 1% drop is a 1L nominal loss. As portfolios grow with time, many investors seek to reduce day-to-day volatility and large drawdowns.
Investing in overseas or foreign equity can provide some geographic diversification.
The rationale for diversification is clear — domestic equities tend to be more exposed to the narrower economic and market forces of their home market, while stocks outside an investor’s home market tend to offer exposure to a wider array of economic and market forces.
In other words, unless there's a big global driver, most of the times, India and US equities won't move up and down, won't move up and down, in same direction nor necessarily with the same pace, simultaneously. Hence moderating the swings based on percentage allocations one takes in US equities.
US equity markets are the largest equities markets in the world. As an investor looking to build long term wealth with equities, over decades, you should have some exposure to largest equity market in the world.
As of 2018, U.S. equities accounted for ~44% of the global equity market, far greater than the next largest market China (~9%). Indian market capitalization was only ~3% of the global market.
Why is size important?
Due to its vast size, most of the retail and institutional investors all over world, would always be chasing US equities, and be willing to take position in this. Its size makes it so that it remains efficient, and provide cues to other markets globally.
Being the biggest market it also attracts companies from around the world to be listed here as getting investing capital is easier in this market. Eg: Spotify (NYSE: SPOT), Makemytrip (NASDAQ: MMYT), Alibaba (NYSE: BABA)
The liquidity and quality of top US stocks are simply unmatched anywhere else in the world.
Just buying different stocks (or other assets) alone, won't automatically result in diversification benefits. The assets into which one is diversifying should have low price correlation with the assets already present in one’s portfolio. Price correlation measures how closely the prices of two different assets are related.
Price correlation can either be positive or negative - the closer to zero, the better. A high positive correlation (approaching
1.0) means that the asset prices move in tandem, offering diversification in name only, while a high negative correlation (approaching
-1.0) would mean that the investments' price movements will virtually cancel each other out, defeating the purpose of investing.
For example, large-cap Indian equity mutual funds will usually have a high positive correlation with the Nifty 50 index; because many of the stocks held by these funds would be from the Nifty 50 space.
As seen in the table below, US markets have historically, had low price correlation with Indian markets
This table based on data provided by Bloomberg, considering prices of these indices between Feb 2005 and Feb 2020.
Nifty 50, Nifty 500 are Indian equities index benchmarks. We use TRI (Total Return Index) to account for dividends.
NASDAQ 100 and S&P 500 are popular US equity indices. Here we also use TRI, converted to Indian currency (INR).
As expected, Indian equity and US equity benchmarks have close to 1 as correlation co-efficient among themselves. But any time an Indian equity benchmark is compared with a US equity index, or vice versa, the price correlations are drastically lower.
Some of the biggest and most famous brands and companies are listed in the US.
Think Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT), Google (NASDAQ: GOOGL), Amazon (NASDAQ: AMZN), Facebook (NASDAQ: FB), Tesla (NASDAQ: TSLA), and many other similar ones.
Most of these companies are also MNCs (Multi National Corporation) and have internationally diversified businesses and revenue streams.
In that sense, taking exposure to US equities can be viewed as getting access to equities growth of companies with global revenue and user-base.
Foreign investments are subject to currency risks. If you're an Indian resident, your investments would be valued in INR (Indian Rupee). And not in USD (US Dollar).
If INR appreciates against USD, then your US investments would lose its market value, and show up as a loss in your portfolio.
Opposite is also true (that's how risk works!) - if INR depreciates against USD, then your foreign holdings become more valuable, as it's priced in INR.
Forex movements would affect your portfolio. In addition to market risks that come with every equity investments, you'd also be assuming one extra risk which would impact your portfolio.
US taxation rules are different from Indian taxation rules.
Depending on how exactly you've been taking exposure to US equity markets, you could be on the hook for various legal and tax-related compliance and reporting.
That adds cost of management (e.g. you having to take the extra time and effort to understand US taxation), and compliance cost (e.g. foreign holdings requiring filing ITR-2 every year during tax filing seasons).
In addition to that, there might be forex exchange costs, remittance costs etc. that'd eat into your portfolio.
Often, investors wrongly assume that investing in US equities would mean higher than Nifty returns.
In reality, diversification works both ways. It's a trade-off.
For example, in 2018 December, US markets dropped in a big way over a period of just last two weeks of the year. S&P 500 was down nearly 20%.
Indian equities were not as affected, over same time-period.
But if someone had wrong expectations of US equities always doing better than Indian equities, and invested on the basis of that; they'd have learned a tough lesson the hard way.
Similarly, towards the end of 2020 and beginning of 2021, Nifty outperformed S&P500 over a period of 3-6 months.
In summary, there'd be periods of underperformance and outperformance from US equities, compared to Indian equities. As an investor, you shouldn't assume US equities always do better than Indian equities.
There are great reasons to invest in US equity. It adds much needed geographic diversification to your portfolio, and gives you exposure to equities that reflect global revenue and economic growths, in a stable currency that's recognized all over the world.
If you can take cost-effective positions in US equities, and have well-tuned expectations; you should go for it.