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Are International Investments Overhyped?

Here’s why Dhirendra Kumar seems to think so

Over the last few weeks, there has been a steady increase in media attention being given to the concept of Indians investing abroad. There are a couple of reasons for this to be happening now. Firstly, a number of fund companies seem to be actively talking up old and new international funds that they are running. Secondly, this hype seems to be finding favour with investors (and the media), perhaps because the case for investing abroad appears to be somewhat stronger today than it was in the past. Or at least, it is easier to claim that it is stronger.

The basic reason that has always been offered by is obviously diversification. This most basic idea in investing is that different types of investments may not lose or gain at different times. Therefore, it makes sense to put money in investments that are mutually dissimilar. However, a close look at the actual performance of stocks around the world indicates that the advantages offered by such diversification may not be as strong as they are supposed to be. Moreover, the argument may be getting weaker just as it being accepted by more investors.

The history of Indian being allowed to invest abroad is not too long. It was just about four years ago that the government first allowed this. At that time, the government placed an overall limit of 500 million US dollars that could be invested abroad through all the funds companies in India. In subsequent budgets, this limit was raised to 1 billion dollars and then to 5 billion.

However, there's isn't much point to this limit till now because the actual investor interest has lagged far behind. I remember at the times when the limit was raised to a billion dollars, the actual investments were around three or four million. The reason for this disinterest was very simple. For the first couple of years after the time when investing abroad was permitted, the Indian stock markets were doing much better than most other markets abroad. At the time, it was thought that the situation could easily reverse and Indians should diversify by investing a small amount of their money abroad.

However, as things have turned out, this diversification may prove to be illusory. The reason is that far more than earlier, there is only one equity market in the world, and that's the global equity markets. While the market commentators' daily recitation of the 'global cues' becomes tedious after a while, the broad direction of the world's stock markets clearly interlinked. The recent credit crisis demonstrated this very clearly. Despite all the talk of decoupling, it was clear that once the dominos started falling no stock market offered a refuge from any other.

This raises doubts about geographical diversification as the logic for buying foreign stocks. There is another problem with global diversification as it is being delivered by most Indian funds. I see a considerable dominance of emerging market stock markets in the fare being dished up by fund managers. Now, this may be easier to sell because it can be talked about, but it isn't great diversification. From a global perspective, investors in one emerging market-India-investing in other emerging markets like China or Latin America doesn't sound like a great idea.

One will know the truth only after some time has passed, but I suspect that investing abroad may not prove to be the kind of diversification that it is being hyped up as being.