Should I now increase my international equity exposure?

Published: November 8, 2022 at 6:00 am

Two readers have the following questions. “Given the relative performance between Indian and US markets, my asset allocation is running low on international equity exposure. (1) Should I now increase my international equity exposure?”

“(2) Is there any ideal rebalance frequency (identified via backtesting)? I’ve usually encountered rules such as – rebalancing once a year/ when your allocation deviates beyond 5%.”

“I try to adjust my monthly investment amount to rebalance every month. I’m worried that this high-frequency rebalancing works against the direction of short-term momentum (I keep trying to catch a falling knife).”

“(3) Do investments into international equity funds gain from dollar-rupee depreciation? I recall Rajeev Thakkar mentioning that they use futures/ derivatives to “nullify this effect” for Parag Parikh Flexicap Fund.”

“(4) Is it more tax efficient to keep one’s international exposure limited to mutual funds with Indian equity >=65%, Given the equity tax treatment, compared to pure international equity mutual funds?”

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    It must be understood that investment in international equity funds is a double-edged sword. Many investors have enjoyed its benefits over the last few years and now appreciate that no market will move up or outperform forever.

    (1) Should I now increase my international equity exposure? Our priority should be equity: fixed-income asset allocation. If this is in line with the risk profile of our need and if we have a risk reduction strategy in place.

    Weights or exposure within an asset class is a secondary consideration. I international equity entices you, then an Indian equity fund holding international stocks like Parag Parikh Flexicap or others – Which funds hold foreign equity-like Parag Parikh Flexi Cap Fund? is the simplest choice. There is lower tax and lower maintenance. The price to pay for this is active fund management risk if that is a chance you are willing to take.

    If you have separate international ( =US!) funds in your portfolio, then the simplest choice is to invest in them systematically in a fixed proportion. If you have Rs. 1000 to invest in equity, then Rs. 800 goes to Indian equity and Rs. 200 to international equity.

    Invest in this ratio without looking at the market levels until it is time for you to start reducing the equity in your portfolio. Any other method will consume and can frustrate you. Also see: Is this a good time to Invest in NASDAQ 100 and S&P 500?

    (2) Is there any ideal rebalance frequency? I have shown that annual rebalancing and threshold rebalancing (when the portfolio deviates beyond 5%) are equally efficient. The threshold method reduces tax incidence, so it is a bit better.

    However, it must be kept in mind that equity exposure should be reduced well before the goal deadline in steps or continuously. So this is a form of rebalancing and takes precedence.

    Trying to adjust monthly investments each month is not rebalancing! It is a waste of time.

    (3) Do investments into international equity funds gain from dollar-rupee depreciation? If the USD-INR exchange rate is not hedged, their returns will be fully influenced by exchange rate fluctuations. Note there have been periods in the past where INR has held steady or even gained against the USD. And INR has been becoming stronger over time. So do not assume INR vs USD is one-way traffic. Basics: Why does the Rupee fluctuate in value against the US Dollar?

    Hedging will lower returns when the INR sharply depreciates. However, hedging also lowers volatility. Parag Parikh Flexicap typically hedges 70-75% of its currency exposure. No one has an issue when the going is good, but when international stocks fall along with the INR, the flexicap fund will likely lose more than funds that do not hedge.

    (4) Is it more tax efficient to keep one’s international exposure limited to mutual funds with Indian equity >=65% As mentioned above, not only is this tax efficient but also labour efficient. The price to pay for this is active fund manager risk.

    Whichever type of fund we choose, what matters the most is goal-based asset allocation, systematic investing and systematic goal-based risk management.

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