Investment tips: Key advantages of global portfolio diversification

Diversification is one of the most obvious, yet the most important, benefits of international investing. Diversification involves spreading investments into different asset classes, instruments, sectors geographies, or other categories, such that each category reacts differently to events in the market. This technique has the effect of reducing the overall risk of the portfolio. For example, if one category of investment reacts negatively to a market event, diversification ensures that there is another category of investment in the portfolio that reacts less negatively, or even positively, to the same market event – thereby reducing the overall impact on the portfolio. This phenomenon is referred to as a correlation between different asset classes.

For diversification to work, it is important for each asset category in the portfolio to have a low correlation with each other. As the below chart shows, Indian markets are historically known to have a low correlation with global markets.

Investing internationally can help investors get access to more developed markets, with opportunities that may not exist in Indian markets. For example, sectors such as e-commerce, search engines, digital OTT platforms, electric mobility, cloud computing, artificial intelligence, machine learning, robotics, etc., may have the potential to offer good growth potential, but the Indian market may have very few listed options in these sectors. Many global businesses belonging to these sectors have also been constant innovators being ahead in their game, and investing in them may result in wealth creation over a period of time.

The Indian economy, compared to developed countries, has had a structurally higher inflation rate, resulting in INR depreciation against currencies like USD, Euro and Japanese Yen over a long period. For instance, the Indian rupee has depreciated 2.3 percent per annum against USD, 3.9 percent per annum against Euro and 3 percent per annum against Japanese Yen over the last 20 years. While it is difficult to form an outlook on currency movements, India being an emerging market could continue to have higher inflation levels as compared to developed markets. Investing in developed market equities may act as a hedge against INR depreciation against their currencies.

In today’s world, diversification of portfolios beyond geographical boundaries is the need of the hour and Mutual Funds provide a convenient avenue for investors to do this. Exposure to international equity certainly merits consideration in the volatile and dynamic world that we live in today.