Say, you are an alien and you just landed in Mumbai. You blended in, think Men In Black, and have now come into some money by commercializing some alien technology. How would you deploy that money? Being unencumbered by the lottery of birth or any nationality on earth, you would want to buy the MSCI Global index—we all know that “smart aliens” invest in the index. That would be about 66% invested in the US markets and around 1% in the Indian markets. This will be different from how most Indians invest, almost everything in Indian mutual funds or stocks.
Of course, most of us are not aliens and we live in India and because most of our economic outcomes, expenses and liabilities are linked to India, we invest disproportionately into the Indian markets. Economists call this the “home bias” or the tendency to invest disproportionately in the stock markets of the country of their birth. Globally, most investors do this. Availability and familiarity with brands you encountered growing up are two of the simpler reasons that explain this home bias.
There is some common sense for that too. As US psychologist Abraham Harold Maslow would have said, fulfil your physiological needs (roti, kapda aur makaan) before you aim for self-actualization. Investing is a similar experience. Your home investments (equity and debt) are the foundation blocks for your portfolio. It is important to ensure that these elements are in proper place (proportion, diversification, among others) before venturing out to other geographies.
Once your domestic portfolio is set, look international. And it is easier now than ever before to do so. International markets offer a lot of benefits and 10-20% allocation to them will make your portfolio more resilient to domestic wobbles. Our recommended portfolio has a 13% exposure to a mutual fund investing in the US markets. The choice is simple, in our view. As mentioned earlier the US is 66% of MSCI global, and US companies generate over 40% of their revenue from global activities. Exposure to the US, at least currently, is a good proxy for global exposure. Further, the US markets have long histories, are deep in terms of liquidity, have strong corporate governance rules and are home to best-in-class companies across multiple industries.
What is even better is that US stocks are not very highly correlated to Indian stocks, so they do not rise and fall in tandem. In a study we ran, we found that over the past 20 years the monthly correlation of returns from the US stocks with Indian stocks is only 34%. On a rolling three-year basis, the correlation is as low as -31%. Having two assets (Indian stocks and US stocks) with positive expected returns and low correlation is the bedrock of having a diversified portfolio. This has been our basic contention for adding gold to the portfolio too. For the same reasons, adding US stocks makes your portfolio more resilient.
But there are two things to watch out for. One, do not let familiarity of the Indian markets breed contempt as the foreign grass looks greener. Two, don’t let peer pressure or recency bias, wherein Nasdaq and S&P 500 have outperformed the globe, push you towards international investing till the time your domestic basics are in place. As a rule of thumb, asset allocation is a good reason and recent past outperformance is a bad reason to buy into an asset class.
But don’t give up on Indian stocks too soon. Things can change quickly given the patterns of capital flows in the post-covid world. In the Indian context, it means that capital will find its way back to our country as it did in the post-2008 scenario. Emerging markets like ours hold potential for higher yield, which will attract inflows. How much will come or by when will they come are questions that can only be answered in hindsight, but capital will chase yield. And when it does, we will see local market rally. At that time, you shouldn’t feel bad about diversifying away from home.
Gaurav Rastogi is founder and CEO, Kuvera.in