Don't invest in dollar-denominated assets only for currency gains

The primary objective of making an investment should be generation of long-term returns and preservation of capital. Any investment should pass through these two fundamental filters. This is imperative and invariably intertwined with a number of other factors that are primary or fundamental, such as the state of the economy, the level of inflation, nature of government policies, corporate profitability and the overall liquidity conditions.

Apart from these factors, there are secondary drivers that determine returns at the periphery. One such secondary factor is currency exchange rate, which is particularly relevant when one makes cross-border investments. Investors in dollar-denominated assets are likely to benefit from the current trend of depreciating rupee v/s the US dollar, as their realisations in rupee terms will be higher. This, in turn will shore up returns as well.

Rationale for cross border investments

The risk of short-term market volatility is always present. When investors make cross-border investments, they have to face an additional risk, that is, currency movement. Therefore, expectations about the desired level of returns should be naturally higher. This is to make it amply clear that mere high returns coming from an overseas investment due to depreciation in local currency should not be the primary consideration while making cross-border investments. Returns should be justifiably higher for the higher level of risk involved due to currency fluctuations.

In the current context, keeping in mind the US dollar-rupee example, the dollar-denominated investments made by Indian investors have done quite well. There are two reasons for the same – (1) the US economic growth has gathered pace, and (2) corporate profitability in the US has improved, sending US stocks higher. Fundamentally, the US economy is in a better shape, and therefore, returns on US equities have been healthy. The recent depreciation in the rupee versus US dollar has added to the gains.

Coming back to India, the level of inflation as indicated by CPI has been quite high on account of fuel and food inflation. The difference between CPI inflation in India versus US inflation has been around 3% on an average for the last five years and the Indian rupee has not depreciated until recently. On a real effective exchange rate (REER) basis, the Indian currency has been overvalued for some time and it necessitated a fall in the currency value versus the US dollar to adjust for the overvaluation. This adjustment has happened post the recent fall.

Advantages of international funds/stocks

As investor needs to look at the portfolio based on the asset class, which constitutes the holdings and the basic asset allocation. Each investor has unique risk profile- risk appetite, risk taking capacity and risk tolerance. Investors can benefit from an allocation to international funds/stocks. The US Dollar-based funds have generated returns in the range of 25-30% and some even higher in the last one year. This is almost double the returns from domestic equities for the same period. However, one must be aware of the rapidly changing global investment landscape that not only brings opportunities, but also throws up new challenges. Buying into a Microsoft, Google, Apple could just give you the edge you were looking at and, that too, from within the comforts through a feeder fund available in India. This diversification in global markets opens up new areas and can be extremely rewarding. At the same time, currency risk is always critical. An appreciating local currency will eat into returns.

The author is CEO of the Emkay Wealth Management