Tushar Pradhan

AMC Speak

2 good reasons for global diversification

Tushar Pradhan



Don’t look only for uncorrelated market returns as the case for global diversification – that can happen, but there are two key reasons why Tushar believes your clients must consider global diversification:

  • For investors who allocate only small amounts to domestic equity out of dislike for volatility, a slice of global equity can sit well between their domestic debt and equity allocations on a risk-return spectrum, to enhance overall portfolio performance
  • There are opportunities beyond domestic shores – in equity, real estate, alternate assets. Food for thought: while we were all very happy with our market’s performance in 2017, India was actually placed in the bottom quartile in global performance league tables.

Read on to understand Tushar’s incisive perspectives on the rationale for global diversification and why he believes HSBC is uniquely positioned to work with you in this area.

WF: To what extent are Indian markets actually uncorrelated or minimally correlated with developed markets? Does historical data establish a case for global diversification of equity portfolios on the basis of risk management?

Tushar: This is an interesting question, as the correlation has been changing over time. A couple of decades ago, we had several trade barriers in many countries including ours. Economies were not as open as they are now. ASEAN countries were largely export oriented, with a strong focus on hi tech industries. India by contrast was largely a domestic story. Indian market was largely uncorrelated with other Asian markets. The Asian currency crisis of the late 1990s of course changed everything. Post that, India’s exports sector started becoming meaningful, led initially by IT and then supported by pharma. As India’s economy became more externally oriented, our markets too became a little more correlated with global markets.

The 2004-2007 situation was very different – we had this global synchronized growth phenomenon and all markets across the globe were highly correlated. Post the 2008 crash this correlation too came off. Developed markets rebounded much faster while emerging markets continued to struggle. You may recall that even in India in 2013, US oriented funds started attracting lot of investor attention on the back of strong performance. In 2016 and 2017, we again saw strong global correlation in market performance.

What this really tells us is that there are periods of strong correlation and periods when this correlation completely breaks down. Over the long term, this points out very clearly to the merits of global diversification as a risk management strategy. There are times when global cycles play out and equally there are times when we don’t see clear global cycles and markets tend to be influenced more by domestic factors.

One trend we are now seeing is the desire across countries led by the US, to raise protective barriers that safeguard domestic players – which can make the world less open than we’ve seen. As trade barriers go up, correlation across markets comes down.

Diversifying beyond your home country gives your portfolio a diversification that reduces portfolio volatility and at the same time allows you to capture opportunities beyond what’s available in your home country.

WF: Is global diversification to be considered purely for equity allocations or is there a case for global multi-asset portfolios for Indian investors?

Tushar: The last 7-8 years have been characterised by an unusually low interest rate environment in the developed world – which really meant that if you are an Indian fixed income investor, there was little sense in diversifying your bond portfolio globally when you were getting 8% + in India and practically nothing in developed markets.

But beyond equity and fixed income, there are a host of opportunities in alternate assets, particularly real estate, which can be of significant interest to some Indian investors. Developed markets metro commercial property is an example of as asset class that sustains HNI interest across the globe but is simply not available in India. Likewise, certain tech based hedge fund strategies, global PE etc are opportunities that are not available in our home country.

So the question really is why shouldn’t an Indian investor have access to a wider range of investment opportunities across asset classes and across geographies.

WF: What in your view is the case for global diversification of Indian investor portfolios?

Tushar: Many investors in India continue to have a very large proportion of their assets in a single asset class – which is fixed income. Its not as if people don’t want to make money – it’s just that the volatility in returns from our equity markets tend to worry many investors and they therefore limit their exposure to equity perhaps below what they really need in order to achieve the desired rate of return from their portfolios to enable them to meet their financial goals.

The need therefore is to reduce volatility of equity portfolios to enhance investor confidence in the asset class. One useful strategy in this context is global diversification of their equity portfolios. This will not only open up a larger opportunity set, but can also serve as a useful risk management strategy.

WF: Why has global diversification of financial portfolios never really gained traction in India despite the advent of feeder funds as well as the LRS facility provided by RBI?

Tushar: One of the biggest deterrents perhaps was that until now, equity funds that invest in India enjoyed “tax-free” status on capital gains while those that go through the feeder fund route to offer international exposure get treated on par with debt funds for tax purposes. That reduced the returns expectations for investors and therefore dimmed the appeal for global diversification. Now that the gap in tax treatment has narrowed, there can be more interest in global diversification.

The second aspect is that an average Indian investor’s returns expectations from equity as an asset class is somewhat higher than his global counterparts, thanks to the long term track records of domestic equity funds. Returns from a globally diversified equity portfolio, even after accounting for currency depreciation of the rupee, could be perhaps lower than Indian long term equity returns, but comes with less volatility. Perhaps the way to look at a globally diversified equity portfolio is that it would sit somewhere between Indian fixed income and Indian equity on a risk-return spectrum. Ideally from a portfolio construction point of view, exposure to a mix of Indian and global equities can encourage investors to go beyond what they would normally allocate to Indian equity alone, which will be beneficial from a portfolio returns strategy. If however one is looking at comparison of returns profile alone between Indian and global equities, investors may not be that attracted to global equities.

Our experience with launching our Brazil Fund bears this out. There was a lot of interest in this fund at launch – investors saw it as another opportunity with a similar return expectation as Indian equities, but with different dynamics impacting its market – and therefore saw it as a good diversification opportunity. Brazil, like India, is an emerging market with immense development potential, has a big domestic consumption story like India, but unlike India, is a significant commodity exporter. India in contrast is a commodity importer which means there can be good benefits of diversification by investing in these two markets.

So I guess a combination of tax disadvantage of the past and a product returns-focused view as opposed to an overall portfolio strategy view have contributed to low appetite for global diversification among Indian investors.

WF: Will hybrid products with a large proportion of Indian equity and a smaller proportion of global equity be a sensible way to get investors more comfortable with global diversification?

Tushar: That’s a good way to begin your journey in global diversification. There is obviously the comfort of a larger allocation to domestic equities. But I would say that’s the starting point, not the destination. We must open our eyes to opportunities beyond India. 2017 was a great year for Indian equities, but how many of us realize that we were actually in the bottom quartile of returns from a global perspective? Most markets did even better than India.

Whether one looks at it from an opportunity perspective or a risk management perspective, there is a good case for global diversification. That case just became more attractive now that the tax differential has reduced. Family offices in India are actively investing globally. Feeder funds offer a convenient way for every Indian investor to invest likewise globally.

WF: In what ways is HSBC AMC equipped to help Indian investors embark on their journeys towards globally diversified portfolios?

Tushar: We have a wide range of products available for Indian investors. We have an emerging markets fund, we have an Asian emerging markets fund, we have a China Consumer Opportunities Fund. This one is an interesting theme – it focuses on companies that are best poised to leverage the great Chinese consumption story. That means great opportunities for global brands like Gucci, LVMH, Unilever, Tencent, Alibaba and so on. This fund buys global companies that are actively leveraging the Chinese consumption story as a growth driver. And then of course we have the Brazil Fund which I spoke about.

For investors who are venturing outside India, there is an added level of complexity of who is the overseas fund manager they are entrusting their money to, what is their investing style, how comfortable are you with their way of managing money. This is where a firm like HSBC, which has a unified globally implemented investment process with PB/RoE as its underlying framework, gives tremendous comfort to investors in India and for that matter anywhere else in the world. When you invest in an HSBC fund – whether in India or any other market, you can rest assured that it will be managed exactly the same way as you know it to manage in your home country, unified by a consistent investment philosophy across geographies. This is a huge competitive advantage for us, especially when the opportunity for global diversification starts gathering momentum and domestic fund houses try to stitch up alliances with overseas players to bring their products into India.

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