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Building a Star-Spangled Portfolio

Indian investors should be paying more attention to investing in US stocks...

If you had started, at the beginning of 2010, an SIP of Rs 10,000 a month in US-focused international funds that was linked to the S&P 500 index, you would have seen your Rs 4 lakh turn to Rs 5.44 lakh, for a return of exactly 20 per cent per annum. Over the same period, a similar investment in the Sensex would have have been flat at almost exactly zero per cent returns. While practically the whole world has been in the doldrums, US businesses have been quietly defying the pervasive malaise that has afflicted all developed economies.

American businesses have even managed to cope with a polity that in some ways is even more dysfunctional than ours. And their stock markets have been paying attention. The Dow Jones index is at an all-time high. Broader indices like the S&P 500 and the NASDAQ 100 are also near all-time highs. The US markets have had just three negative quarters now since January 2009.

And all this isn't something that has happened suddenly, it isn't part of some trend that has taken investors by surprise. Unfortunately, in practice, it has taken Indian investors by surprise. Investments in US-centric funds, of which there are several available in India, have hardly been of any significant scale. These funds have total assets of just Rs 366.24 crore, a tiny fraction of what Indian investors have put into domestic funds.

We are not making the case that you should pick a big chunk of your money into funds that invest in the United States, but you are almost certainly investing less money there than you should be. We have written about the logic of international investing a number of times since 2004, when the Government first permitted Indians to invest abroad. During these nine years, a large variety of international funds have been launched by Indian AMCs -- a total of 32. Most of these funds are flavour-of-the-day thematic funds that are basically useless for any intelligent investor. However, there are still 18 diversified equity funds out of which 4 invest only in the US.

The counterpoint to all this is that for many years now, economic numbers from the US have been fairly dire. Over the last three years, GDP growth has averaged 2.3 per cent. The current account deficit is a large 3.1 per cent of GDP (India's is around 6 per cent). Gross government debt as a percentage of GDP is a mind-boggling 107 per cent (India is a high 68 per cent) and the Federal budget deficit is 8 per cent of GDP. No one who has any familiarity with global economic news would be aware of the state of affairs.

The case to invest in the US
So how can we tell you that US equity funds are a good investment? The answer is simple. As foreign equity investors, the aggregate state of the US economy does not hold much relevance for us. What matters to investors is whether there are enough good stocks for them to buy. We in India are used to stock markets being deeply linked to the state of our economy. But that's because we are at a different stage of development and a large proportion of our stock markets are businesses which are overwhelmingly domestic. When the Indian economy does badly, or when the Indian government messes up something, then these businesses do badly.

Businesses in the United States are a very different kettle of fish. The bellwether stocks that dominate US stock markets and the portfolios of US-centric funds are heavily globalised companies that derive a decent proportion of their sales and profits from outside the United States, much of it from high growth emerging markets. In 2011, the last year for which full data is available, foreign sales accounted for 46.5 per cent of the total sales of S&P 500 companies. Of this, 30 per cent were from Asia, Africa and Latin America.

Effectively, these are global companies which combine some of the best characteristics of the America's pro-business environment with a global footprint. Some of the largest companies that are there in the portfolios of US-focused funds fall in this category. 66 per cent of IBM's sales, 62 per cent of Apple's, 60 per cent of Pfizer's and 54 per cent of Google's sales come from outside the United States (see table for the top-15 of this list). If you'd like globalisation to be more than just a buzzword in your investments, then investing in US bluechips could well be the best way to build the core of a global portfolio.

Moreover, this optimism is not just limited to the businesses and stocks of US companies with global presence. While reading foreign business news, we in India do not realise that compared to us, the US has a far more positive business environment even at the worst of times. There's a much quoted saying 'The business of America is business' and that's very true.

For one, the innovation engine of the US economy is spinning just as fast as ever. Research and Development investments is 2.9 per cent of GDP, or $405 billion, easily the highest in the world and about 40 per cent of the global total. Moreover, the rest of the working environment is tuned to derive benefit from this R&D expense rapidly. Take the shale gas revolution. Energy imports are the Achilles' Heel of the US economy.

However, over the last few years US businesses have developed and deployed on a massive scale the technology to extract natural gas and oil that is suspended in microscopic pores in rocks. Between 2007 and 2011, US production of such gas rose by more than four times while total natural gas production rose by more than 50 per cent. The country is now the world's largest producer of natural gas. Gas is now so abundant that electricity prices have fallen sharply to as low as $0.08 per unit. On a purchasing power parity basis, this is about 1/10th of what we pay in India and far lower than what diesel backup power (which is what a lot of Indian businesses actually use) costs to Indian businesses.

Recently, you must have read the news that the US quota for H1-B visas, under which Indian IT workers fall, was exhausted within five days of opening. In the Indian media, this was interpreted as bad news for Indian IT services companies. Actually, this is great news for IT companies and also for those who'd like to invest in the US. H1-B visa demand is a great leading economic indicator on how positive business in America is. During the growth years of 2003-2007, the H1-B quota used to finish within days. Then came the slump and it would stay unused for months. Now, it's back to the growth days. US companies are spending rapidly on IT projects, something that everyone should be happy about.

All figures as on April 5, 2013.