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In a scenario where there are supply chain shortages, inflation is driving up the cost of money, commodity and commodity prices are breaking all records; The US Federal Reserve was expected to hike rates by 50 basis points after raising the CRR and repo rate. Inflation usually shows signs of calming down over the summer, but US announcements of a deal with European leaders to increase natural gas supplies have signaled investors that there will be no fall in energy prices over the summer and that there is inflation in America. Staying there longer than expected.
Inflationary pressures, which could prompt the Fed to hike rates by as much as 300 basis points, have fueled risk aversion. Despite fair valuations, investors appear to be withdrawing from investments. The US Federal Reserve’s interest rate hike will allow the US dollar to appreciate against all world currencies, including the Indian rupee. Rising interest rates are making US cash more attractive, and as a result, investors are fleeing emerging markets over the perceived safety and attractiveness of US fixed income. In May 2022 alone, FIIs withdrew Rs 6,400 crore from Indian markets.
The risk-averse mode will mainly invest in debt, and most of it facing west, the debt component should have characteristics such as flexibility and low volatility in the domestic market. This is where short duration funds become extremely attractive in a rising interest rate environment as they are least affected and then have the opportunity to take refuge in commercial paper at higher interest rates.
Target term funds work well, especially when they have a short term. It’s always better to avoid being locked into this rate for a long time, but if you can sustain volatility then four-year gilt funds can be expected to generate returns in excess of 6 percent. The idea is that even if volatility is bound to change the NAV during the holding period, the funds will deliver a net return to maturity (YTM). It should be noted that the taxation with indexation is 20 percent when opting for these long-term gilt funds of more than three years. So the YTM total cost is what investors should pay attention to.
In terms of the equity component, investors should ensure that the companies they own are cash flow positive, have strong pricing power and have no debt on their balance sheets. NASDAQ’s technology companies bring out these monopoly features. Improvements in these consumer discretionary companies have made their valuations even more attractive.
With the US dollar being the world’s fastest appreciating currency, investors need to build USD wealth for current and future USD liabilities such as international holidays and Ivy League education for their children. This leads to constant spending in dollars.
In addition, the Indian rupee has depreciated by around 3.5 percent on a long-term average. Depreciation isn’t always linear, but the trend is likely to continue in spurts. In fact, the rupee crossed the 77 mark much earlier than expected. Meaningful diversification for USD investments protects against INR depreciation to a certain extent.
USD is the reserve currency and USD assets can be of great help in times of crisis. To manage geopolitical risk, investors need access to offshore USD investments.
The geopolitical situation has led to a significant increase in inflation and an appreciation of the US dollar against all currencies. This appears to be attracting investment in US markets, but in the case of India, the Liberalized Remittance Scheme (LRS) appears to be the only option available for some time.
Many Indian mutual funds invest in internationally listed companies. Some of them are feeder funds, raising money from Indian investors and buying shares in actively managed funds based outside of India. Currently, this option is not available as the Indian mutual fund industry has reached the $7 billion limit set by SEBI. Another category of Indian mutual funds investing in internationally listed ETFs has a SEBI limit of $1 billion, which is likely to be reached in due course and therefore may not even be a viable option. As this investment mode remains denominated in INR, it offers diversification benefits and no exposure to USD currency.
The RBI allows remittances of up to $250,000 per person in a fiscal year, this is known as the LRS (Liberalized Remittance Scheme). This transfer applies to all your foreign exchange spending including investments outside of India. These investments can be made in ETFs, stocks and actively managed funds. The money may also be channeled through a few boutique investment managers pursuing specific focused strategies centered on growth companies with high ROE and free cash flow. The benefit of the LRS route is that the accumulated investments can be sold/redeemed at any time to generate a larger USD balance that can be used for any spending/investment. We have seen HNIs increasingly using these borders to remit funds outside of India and gradually build a corpus of offshore wealth.
With the SEBI cap for Indian funds investing internationally, investors are resorting to increased LRS where the limit is not on the fund itself, but on the individual, which in turn is re-established every financial year.