In the ever-evolving world, financial markets are intricately connected and influenced by multiple factors, one challenge that has come to the forefront is the continuous depreciation and volatility of the Indian Rupee (INR) against the United States Dollar (USD). The INR has depreciated by over 12 percent against the US Dollar in the last three years and is looking to continue to weaken further.
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As this trend persists, it has become increasingly evident that safeguarding investments against currency risk is not just a prudent move but a necessity from risk adjusted returns perspective and to stay competitive in global markets. Considering this, one approach could be diversifying investment portfolios into USD-denominated financial assets. Further, the recent series of geopolitical events also necessitates geographical diversification of investment portfolio.
Such a portfolio diversification also helps with meeting future foreign currency liabilities, such as children’s education, without incurring the painful currency depreciation cost. This strategy not only acts as a shield against currency risk but also opens compelling investment avenues.
Deciphering the Currency Dynamics
The performance of the Indian Rupee against the US Dollar is a complex interplay of economic fundamentals, trade balances, geopolitical developments, and monetary policies. The INR's consistent depreciation against the USD demands the attention of investors who seek to mitigate potential loss of global competitiveness and capitalise on market dynamics.
Diversification for Risk Mitigation
Diversification is a prudent investment strategy. By allocating resources across various asset classes, regions, and sectors, investors can substantially reduce the impact of volatility in any single area of their portfolio.
Geopolitical events can have a significant impact on the economy and financial markets for specific regions. They can create uncertainty, disrupt trade, influence commodity prices, and lead to changes in government policies, all of which can affect liquidity and value of investment portfolios. Against the backdrop, diversification serves as a robust defence mechanism to mitigate the risk stemming from currency fluctuations.
Unlocking the Potential of USD-Denominated Assets
The solution lies in the strategic but gradual shift towards USD-denominated financial assets. These assets hold a distinct advantage by virtue of being insulated from the currency fluctuations of the home country. The US Dollar, a universally recognised reserve currency with a track record of stability, presents a compelling option for global investors seeking a safe haven outside of their home currency.
Capitalising on Elevated US Interest Rates
The recent surge in US interest rates, witnessed over the past year, reverberates across the financial landscape. This development impacts borrowing costs, corporate profitability, and investor sentiment. However, it also ushers in a unique opportunity for investors aiming to optimise returns on fixed-income investments.
Traditionally, the borrowing costs in USD denominated markets have been lower than INR local markets, however, currently not only has the spread compressed to historical low levels, in some cases USD borrowing costs have even crept higher.
The Indian Advantage in USD-Denominated Bonds
While Asia’s credit and corporate bonds face headwinds, Indian issuers stand out with their credibility and stability. A meticulously crafted portfolio of select USD-denominated bonds issued by esteemed Indian institutions, created in line with applicable Indian regulatory guidelines, holds the promise of an attractive investment avenue.
Credit Rating Matrix
India’s global credit rating currently stands at the lowest investment grade according to global credit rating agencies. However, despite boasting a robust balance sheet and an impressive credit profile, Indian corporates find themselves constrained by the sovereign rating ceiling. As a result, investors can obtain yields that typically align with lower investment-grade assets while still benefiting from the relative security of credit risks that are on par with higher-rated counterparts. With a stable economic environment and promising growth prospects, there are optimistic expectations of an impending sovereign credit rating upgrade, a development that could further enhance the appeal of these bonds.
The Math
Select USD debt instruments issued by investment grade rated corporates are available at yields higher than INR yield. Investors can participate in pool of such securities that is created to align with applicable regulatory guidelines with respect to remittance and usage of funds abroad (Liberalised Remittance Scheme), offering annualised yield in the range of 7.50 percent to 9 percent. Going by the long-run average depreciation of domestic currency, realised returns can potentially be even higher.
Conclusion
In an era defined by economic uncertainty and market fluctuations, investors face a challenging task of safeguarding their portfolios while maximising returns. The persistent depreciation and volatility of the INR against the USD necessitate a proactive response to keep the portfolio value competitive. Diversification into USD-denominated financial assets emerges as a strategic shield against currency risk. The surge in US interest rates augments this opportunity by enhancing the appeal of fixed-income investments.
By participating in a curated portfolio of USD bonds, investors can navigate the global financial landscape with better risk adjusted returns. The convergence of factors at this juncture highlights the timeliness of such a strategic investment shift. Investors should ideally seize this moment to not only shield their investments from currency volatility but also to unlock the potential of a diversified and stable portfolio.
—The author, Deepak Sood, is Head – Fixed Income, at Alpha Alternatives. The views expressed are personal.
Disclaimer: An investment with Alpha Alternatives (including its subsidiaries) is suitable only for sophisticated investors and requires the financial ability and willingness to accept the high risks and lack of liquidity inherent in any such investment. This article is not intended to be comprehensive or to provide specific investment advice or services. The article is not in any form a substitute for such professional advice or services, and it should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business. Before deciding to invest, prospective investors should read the definitive offering and subscription documents and pay particular attention to the risk factors contained therein. Persons who are not relevant persons must not act on or rely on this document or any of its contents. Any investment or investment activity to which this document relates is available only to relevant people and will be engaged in only with relevant people. Any decision or action taken by you based on the information contained herein is your responsibility and Alpha Alternatives is not liable in any manner for the consequences of such a decision or action. In deciding whether to make an investment with Alpha Alternatives, you must rely on your own evaluation of the terms of the proposed investment and the merits and risks involved, and, if applicable, upon receipt and careful review of any confidential memorandum, prospectus, or similar documents, and you should consult your legal, tax, investment, or other advisor. The contents of this document do not constitute and should not be construed as legal, tax or investment advice. Although Alpha Alternatives has used all reasonable efforts to ensure that the information provided in this document is correct, Alpha Alternatives and its members, partners, stockholders, managers, directors, officers, employees, advisers, representatives, and agents make no representation and give no warranty that such information is accurate, complete or current, and you should not rely on the information provided in this document for any purpose.
(Edited by : C H Unnikrishnan)
First Published: Oct 10, 2023 9:52 AM IST
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