Non Resident Indians and the falling dollar

Non Resident Indians (NRIs) that have plans of retuning to India are obviously concerned about the falling dollar. Just this year, the dollar has fallen by more than 13% (as compared to the rupee) and is still falling.

One has to now contend with India's rising inflation AND the depreciating dollar - that's a double whammy and cause for much concern.

I don't buy the official Govt inflation numbers (neither the US govt, not the Indian Govt). Frankly speaking I don't know how they come up with numbers that are so grossly inaccurate. Govt of India puts inflation at 4.5% (or thereabouts) - that's not even CLOSE to the real number.
And the same goes for the US inflation numbers (under 4%) - have you checked the price of gas and milk lately? Have you renewed your apartment lease yet? Oh I forgot - they don't consider these aspects when coming up with the inflation number - well what do they consider? - sorry for digressing, maybe I should leave this for another post.

OK so coming back to the NRI situation. Interest rates in India are close to 9% for Fixed deposits (10% for senior citizens) - mainly to keep up with rising inflation (which is officially at 4.5% - ha!). Interest rates in the US are around 5% and dropping.

Lets say you are an NRI and have an asset allocation plan that is 60% diversified stock and 40% fixed income (all held in dollars) and you plan on retiring in India. In this portfolio, the cause for most concern would be the 40% (fixed income that is earning 4%-5% in the US). If this is held in dollars, it is going to be tough to keep up with inflation in India (which is a lot higher) and one of the most important goals of fixed income is to AT LEAST keep up with inflation.

So how should you tweak your overall portfolio if you plan on retiring in India?

• Hold your long-term fixed income allocation in rupees in India. That way it will keep up with inflation in India. You can diversify across bank fixed deposits and debt mutual funds
• Also hold the India part of your stock allocation in rupees in India
• Hold the rest of your diversified stock allocation in dollars in US mutual funds

This way, the fixed income portion of your portfolio will fulfill its goal of AT LEAST keeping up with inflation in India. Also, you will still hold a widely diversified stock portfolio (by keeping that in dollars in the US) which you would not be able to do if you moved everything to India. India does not have any "international" equity funds that invest outside of India and you will lose the diversification of your stock portfolio if you pull out everything from the US and invest in India. And you never know, the dollar may come back in the next 10 years - then what?

So to summarize - move your fixed income allocation and India stock allocation to India. Hold the rest (diversified stock) in US Mutual funds. And don't forget to pay taxes to Uncle Sam for the interest that you make from your fixed income allocation in India.

Due credit for this idea should go to some folks over at the R2I Finance forum (link on right nav)

Related posts

Post1 - Rupee and dollar
Post2 - Investing in India - different strategy

Some mutual funds in India that I like

When I first started researching mutual funds in India, I found it to be quite overwhelming. There were so many categories of funds and each had a growth and dividend option just to make things more confusing. There were some "new" categories like FMP (Fixed maturity plans), MIP (Monthly income plans), Principal guarantee funds (like thats ever possible if your fund has any kind of equity exposure :-)), ULIPs etc etc. When the dust settled from my research, I thought that I could possibly set up a decent portfolio with 4 or 5 funds (one index fund, one debt fund, one mid-cap fund and one diversified equity large cap fund)

For the index fund category, I like the UTI Master index - its one of the oldest index funds and has a solid record for over 5 years. It has a lower than average expense ratio in its category and no front end load (as is with most index funds).

In the debt fund category, I went with the HDFC Floating rate fund ST, mainly because of its low expenses and low sensitivity to interest rate fluctuations.

In the diversified large cap category, the 2 funds I like HDFC Top 200 and Reliance Growth

In the mid-cap category, the Sundaram Mid cap fund stands out IMO

If you are looking for a balanced fund, then take a look at the HDFC Prudence fund. It has a stellar record going back 10 years. I have never heard anyone say or write one negative thing about this fund - its a winner and cuts down on volatility since it holds about 20% of its portfolio in bonds

I think one can stay away from the FMP's, ULIPs, MIPs, ultra short/liquid and long term debt funds, principal guarantee funds, sector funds and fund of funds etc - stick to "bread and butter" funds and still create a well diversified portfolio that will do well over the long term.

P.S - I wouldnt touch a ULIP scheme with a 10 foot pole!

Assessing your risk profile and rebalancing to it

One of the first steps to building an Asset Allocation Plan is to assess your risk tolerance. What kind of an investor are you? How much of a loss in your portfolio can you live with without spending sleepless nights? Do you have the "courage" to throw more money into the market during a downturn or will you sell in panic?

Be brutally honest with yourself and one certain way to test this is to live thru a downturn (we have had a few in the last 7 years, including the dot com bust in 2000). Think carefully about how it affected you - what was your reaction, what thoughts crossed your mind, did you reach your breaking point, did you break, did you sell in panic, did you buy like Braveheart?

If you can accurately guage your risk profile (believe me, its not easy) you can come up with a very important aspect of your asset allocation plan - the split between your equity holdings and fixed income, or in other words, your stock to bond ratio. This will form the basis of your financial plan and once you decide on it - stick to it no matter what.

For example, I like Larry Swedroe's (author and regular poster at the Vanguard Diehards forum at Morningstar) rule of thumb to determine stock bond allocation. Take your maximum acceptable loss percentage, multiply that by 2 and that should be your stock allocation. Meaning, if the maximum loss you can digest without panicking is 30%, then multiply by 2 = 60%. You should not hold more than 60% of your entire portfolio in equities.

Another rule of thumb is - invest your age in bonds and (100-age) in equities. If you are 35 years old, then hold 35% in fixed income and 65% in equities and adjust that as you get older.

Whatever be the allocation you choose, it is important to adhere to it - that is the only way you can be successful over the long term. And this leads us to the concept of rebalancing.

Lets say you came up with an allocation plan of 65% stock: 35% bonds based on your risk profile and are fully invested as such on Jan 1 2007. In Dec 2007, you look at your portfolio and you see that because of the continuing bull market in equities, your equity % of your total portfolio is now 70% and bonds make up only 30% of your portfolio. This would be a good time to rebalance - meaning make changes so as to bring your allocation BACK to 65% Stock : 35% bonds.

Now - how often should one rebalance, and how should one go about doing it

• My suggestion is to rebalance once a year or if your allocation is out of whack by greater than 5% - whichever comes first
• Rebalancing can be done with new money or old money. If you want to increase your bond allocation by 5% to bring your allocation back to a 65:35 split, add to your bond funds (buy 5% worth) with new money (salary savings etc). To use old money, sell 5% of your equity holdings and add that to your bond funds
• When rebalancing with old money, try to do the re-balancing inside of a 401k or IRA, so when you sell the equity it is not a taxable event, making your rebalance tax efficient

The act of rebalancing is an automatic way to "book profits" - now you dont need to ask - when should I take some off the table or is this a buying opportunity. If your overall stock allocation increases by more than 5% sell stock and buy bonds. If its the other way around, sell bonds and buy stock. If you allocation numbers have not changed significantly, do nothing. The selling/buying calls can be made based on your allocation numbers at any given time. Its a thing of beauty - cruise control baby!

Investing in India - different strategy?

When I compare the Indian market and the investment instruments available there (Mutual funds in particular) with the US market and its available funds, I see the following, that could have a bearing on what kind of an Investment strategy might work in India.

• As compared to the US market, the Indian market is quite "inefficient", meaning that it is not as hard to beat the overall market indices in perfomance. This is proved by the fact that a majority of actively managed funds consistently beat the index. The reverse is true in the US. So in my opinion, true indexing has not (yet) come of age in India, but will in the future as the markets get more efficient.
• Average Mutal Fund expenses in India are quite high (in the 2% - 2.5% range for equity funds). In addition to the high expenses, most equity funds charge a 2% - 2.5% front end load which makes the overall expenses bordering on absurd. The Indian markets have not seen a significant down year in the last 4 years or so and that is why not many people are concerned about these loads and expenses....reason being that if your fund is making 60% in the year, whats 5% in expenses in loads. But if your fund has a negative return year....hmmm the fees and loads hurt a lot more.
• From a tax perspective, investing in India is a dream. Long term Capital gains tax (if you hold for 1 year or more) for equity oriented funds is zero - zilch - nada and LTCG on debt funds are 10%. These make for HUGE advantages (as compared to US taxation) when it comes to tax savings.
• Debt Mutual Funds are not as popular in India. Due to the extended bull market in equities and a rising interest rate environment, debt instruments have taken a back seat. Also, they dont enjoy the favourable tax treatment like equity funds. Lets wait for the first signs of an extended bear market and things may change in favour of debt instruments.
• A lot of people in India still believe that Whole Life Insurance policies (ULIP schemes) are the solution to their long term financial troubles. As a result (unfortunately), these horribly expensive and mediocre perfoming schemes are still very popular.
• As far as overall volatility is concerned - India, an emerging market is a whole lot more volatile than the US markets. In my portfolio, I have seen swings of 30% in a matter of months.
• A big drawback in the Indian markets is the lack of any decent international funds. So the average indian investor cannot diversify outside of India. It is high time the Indian Fund houses stop dishing out 5 versions of what is essentially the same fund and concentrate on opening up some new international funds to their investors. I read an article recently that this is indeed in progress - hopefully they will come out with something soon.

Given all of the above, what could be a good investment strategy in India? IMHO

1. Pick funds with lower than average expenses and loads in their respective category
2. Invest via the SIP route (Systematic Investment plan). This will help protect your investments against the perils of a volatile market. Also, most funds cut down on the FE load if you invest via SIP
3. Diversify across fund houses (managers)
4. Do a mix and match of index funds and actively managed funds. Since India is not yet an "efficient" market, pure indexing may not work as well as active management
5. Stay away from sector funds and NFO (new fund offerings)
6. Learn to accept volatility and invest only for the long term (and by long term I mean more that 3 - 5 years). I heard some "expert" on TV the other day saying that that "long" term means 6 months or more :-)

Fund picks coming up next........

Rupee and the Dollar - cat and mouse game?

Not breaking news anymore, but the rupee is at an all-time high with respect to the dollar. So what.....?

# Well for starters, if you work in an software outsourcing company like Wipro, TCS, Infosys to name a few, or hold their stocks you would have felt some pain :-). These guys earn in dollars/euro etc but their costs/wages are in rupees. So if the rupee gets stronger, it eats into their margins.

# If you are thinking of retiring in India you would have seen your net worth take a 10% haircut.
And there's a double whammy - In an ideal scenario, lets say we have country I (India) with Inflation of A% and country U (USA) with inflation of B% and A is much larger than B and growing, then currency of U should appreciate against currency of I to offset the inflation (A-B). But look at the dollar - its going in reverse.

Where the rupee is headed in the future I don't know, but I believe the software lobby is too strong to let the dollar keep sliding. India will lose the "low cost" advantage that started the growth story that is India today. I'm sure the outsourcing bigwigs have had "talks" with the RBI to intervene (read buy forex to stop the dollar slide). Now, what was the compromise number that they agreed upon - 39, 40, 41 - time will tell :-)

So what can you do to hedge against the falling dollar (not only wrt to the Rupee, but other currencies as well)?

1) Invest a part of your portfolio in International Mutual funds. These funds will rise in value when the dollar falls (over and above the appreciation of the underlying equity)
2) Invest in commodities

"Irrational exuberance" back home?

Here is what scares me about the Indian markets, which have been on an absolute tear over the last 4 years and I'm talking doubling your money in a year kind of gains just by investing in the Sensex - amazing!

The scary part.....

1) Everyone's talking about stocks and dishing out tips (even at kid's birthday parties)
2) Sharply dressed 20 year old financial "advisors" are a dime a dozen and Mutual Fund houses are offering new "hot" funds every other day
3) The art of picking stocks has gotten easy - since everything has been going UP
4) TV channels are abuzz about the bubble (sorry - India growth story) and now we have official headcounts of dollar millionaires.
5) How can we ignore/neglect the infrastructure/corruption/poverty issues that India has to deal with going forward

My personal take on the situation is yes, Indian markets are at an all-time high right now and if I were to put fresh money to work at this point, I would hesitate.

BUT, that being said - I do believe in the growth story of India and 10 years from now, I think the SENSEX will be much higher than what it is today - so if you are a long term investor (as you should be) and can handle some volatility (I have personally seen my India portfolio take a 30% hit in one month - only to bounce back in the next couple of months) investing in India is a good option.

I'll keep the "how to invest in India" for later.