With the US Federal Reserve making ominous noises about rate hikes every now and then, Indian equity markets are going through bouts of nervousness.
To reduce the impact of such volatility on your portfolio, financial advisers usually ask you to buy gold, allocating 5-10 per cent to it. As Indian gold prices reflect global prices adjusted for rupee-dollar exchange rates, owning gold gives you an exposure to the US dollar.
But if you are not a risk-averse investor, you should consider US equities instead. By owning US equity funds, not only can you reap returns from dollar strength, you also get to participate in the earnings growth of world-class companies that are listed in American markets. There are three arguments in support of diversifying into US equities in place of gold now.
One, India’s economy may be growing at a faster clip than the US, but the US equity market often manages to outperform India’s due to the sheer variety and quality of companies listed there.
The five-year CAGR (compounded annual growth rate) on the US S&P 500 index is at well over twice the return managed, both by domestic gold funds and the Indian equity market (the S&P BSE 500 Index). Its three-year and one-year returns are ahead of both gold and Indian markets, too (See table). This is even without reckoning the impact of exchange rates on returns.
Bringing the rupee-dollar exchange rate into this equation makes US equities look even better. If we consider returns for an Indian investor, US equities have delivered a stunning CAGR of 23 per cent plus over both five and three years and 12 per cent in the last one year, after factoring in rupee depreciation.
In fact, despite the very different growth trajectories of the two economies, US equities for rupee investors have nearly matched Indian equities over a 10-year period. The other advantage of owning US equity funds in place of gold is that by buying them, you are essentially buying into global companies with good profit prospects.
Gold without QE
But the ten-year returns on gold still look pretty good relative to both the Indian and US markets. So isn’t gold a much better bet? Well, it isn’t, because the 14 per cent return on gold over the last ten years is an aberration. These returns have been propped up by the spike in investment demand for gold between 2008 and 2012, first by panic over the global credit crisis and then by the flood of easy money unleashed by US quantitative easing.
Without these props, especially if the US economy returns to recovery mode, gold is likely to revert to its long-term returns of 8-10 per cent. US equities may fare much better.
Low correlation
But isn’t downside protection the key reason why anyone would diversify from an equity portfolio? Given that Indian stock markets take pretty nasty hits during bear phases, won’t gold be a better protector of value than overseas equities?
That is true. Running a correlation based on yearly returns for the last 10 years shows that gold has carried a marginally negative correlation with Indian equities (minus 0.1), which suggests that when equities tank, gold may hold its ground. The US equity markets, adjusting for exchange rates, have displayed a small positive correlation with Indian equities (plus 0.2).
Both in 2008 and 2011, two down years for the Indian stock markets when the indices tanked by 58 per cent and 27 per cent, respectively, gold managed gains of 26 per cent and 31 per cent, respectively. Indian investors in US equities, would have made losses of 23 per cent in 2008 and gains of 21 per cent in 2011.
But the problem is that with waning investment demand, in the last one year, gold has tumbled right along with equities. While Nifty and Sensex have tanked 6 per cent, gold ETFs have lost 6 per cent in the last year.
Overall, if you believe that the world economy is set for better times, you should hold faith with Indian stocks and park 5-10 per cent of your portfolio additionally in US equity funds. ICICI Pru US Bluechip Fund, Franklin US Opportunities and funds like PPFAS Long Term Value are good funds, with varying degrees of US exposure.