Globally, shares have experienced a lot of volatility in recent years. In March 2020, we had a severe downcycle event (Covid-19), with markets correcting 29 percent, followed by a rapid rally, with stocks quickly rebounding to all-time highs around the beginning of 2022.
Markets have been jittery recently as tensions between Russia and Ukraine have grown to the point of conflict. This caused a shift in investor mood around the world. From its peak in January 2022, the MSCI All Country World Index (ACWI) saw a -10.6 percent drawdown (down from the peak to the trough).
Owing to a further rise in commodity prices, particularly oil and industrial metals (commodity prices were already higher before the war due to strong demand recovery and supply-side difficulties), risk aversion and concerns about the de-rating of high earnings expectations weighed heavily on Indian shares.
The investor's biggest downside risk is oneself, which is a harsh reality of investing. While short-term disruptions such as rising inflation, market crashes, and pandemics can all occur, persistent damage is more likely to occur when we make poor financial decisions based on greed or fear.
How can investors keep their downside risk to a minimum?
Diversifying into protective investments like cash and fixed income can help to mitigate negative risk. However, present low or negative real rates — that is, once inflation is factored in – do not make it profitable for investors to park a significant percentage of their money.
Investing in global equities with local market exposure has historically helped investors build wealth at a moderate risk level, as drawdowns are lower in a globally diversified portfolio than in a portfolio invested solely in Indian equities.
To put things in perspective, during the epidemic, MSCI ACWI lost 29% of its value, compared to 38% for the S&P BSE 500 index. Going back in time, global stocks corrected by 46% during the global financial crisis (GFC) of 2008, but Indian equities dropped by 66%.
Equities as a growth asset, of course, rebounded strongly after both significant drops.
There are various reasons why investing in global equities can result in lesser drawdowns.
In terms of fundamental diversity, we believe that global investing provides exposure to a wide range of international economic and fundamental growth drivers, each of which reacts differently to unforeseen events.
It also protects against rupee depreciation, increasing the overall asset return. The figures are self-evident. Over the last decade, US shares have returned 19.3 percent annually in INR terms, surpassing Indian equities by a large margin, which have returned 14.9 percent. As a result, retail investor interest in global stocks, particularly U.S. equities, has increased.
Historically, Indian investors could diversify into global equities through funds based in the country. The global funds' category assets were trailing at INR 4,200 crores pre-covid (February 2020), and by March 2022, they had expanded to INR 38,000 crores, with roughly INR 22,000 crores invested in U.S. equities funds. The euphoria around FAANGM stocks in particular attracted retail investors.
Strong inflows into global funds prompted the regulator to intervene, and the regulator advised mutual fund managers to halt further investments in foreign stocks by the end of January to avoid exceeding the RBI's overseas investment limitations.
According to the rule, each mutual fund can invest up to $1 billion in foreign markets, with a total industry cap of $7 billion. The regulator was widely expected to raise the foreign investment restriction. However, because that did not happen, fund companies were forced to suspend accepting new international fund flows on February 2nd, limiting investments to existing SIPs or STPs.
As a result, demand for overseas ETFs soared, despite limited availability and liquidity. The result is that ETFs' recent performance has deviated from the benchmark they are tracking. For example, the Nippon India Hang Seng ETF returned -0.85 percent from February 1 to April 27, 2022, compared to -14.3 percent for the Hang Seng index it tracks. The underlying Nasdaq 100 index returned -10.51 percent, while the Motilal Oswal Nasdaq 100 ETF returned -1.71 percent.