Index Funds: Can They Help Diversify Your Portfolio Internationally?

Are you looking to invest globally? Do you seek an investment that tracks foreign stocks? You could invest in index funds exposed to a global stock market index. It passively tracks stocks of top global companies such as Google, Netflix, Amazon, and Facebook, helping you diversify your portfolio internationally. Should you diversify your portfolio globally?

Can index funds give you international exposure?

Index funds are passive investments that track and replicates a stock market index portfolio. For instance, Nifty Index funds mirror the Nifty 50, a benchmark Indian stock market index. However, there are Indian index funds that track global stock market indices such as the S&P 500 or the Nasdaq 100. 

You may invest in an index fund that tracks and replicates the portfolio of the S&P 500 Index. It offers exposure to the top 500 US Companies covering 11 Global Industry Classification Standard Sectors, making it a broad-based diversified stock market index. 

Why diversify your portfolio internationally?

You can diversify your portfolio with exposure to a foreign stock market that has a low correlation with the Indian stock market. For example, the US and Indian stock markets have a low correlation of 0.29. Experts recommend that you have around 5%-10% of your equity portfolio in International investments. 

You can diversify your portfolio to get exposure to a foreign currency such as the US dollar. For instance, you may incur expenses in US dollars in the future and investing in international funds helps you get the requisite exposure to a foreign currency. 

If you seek exposure to a global theme, you can invest in international funds. For instance, the USA is the pioneer in robotics, artificial intelligence, machine learning, electric vehicles, industrial automation, and you can invest in unique investment ideas. 

Should you invest in index funds with exposure to foreign stock markets?

Index funds try to replicate the portfolio of a stock market index and offer returns that match this index. For instance, a domestic index fund that tracks the S&P 500 provides returns that match this index. 

Moreover, many actively managed funds fail to outperform their benchmark indices even in the US. It helps to understand that investing in an index fund offers returns that match stock market returns. 

As index funds are passively managed, they have a lower expense ratio than actively managed funds. The expense ratio is the cost of managing the mutual fund, and you must choose index funds with a lower expense ratio to raise overall return over time.

Index funds that replicate international stock market indices are fund of funds or feeder funds. It is a domestic mutual fund that invests in a foreign mutual fund that tracks global stock market indices. You will incur a higher expense ratio due to exposure to two mutual funds. 

What are the risks associated with International funds?

You must invest in international funds only if it matches your risk tolerance. Moreover, you must be mindful of the economic and political conditions in the foreign economy before investing in international funds. 

You must understand currency risk or the variation in the price of one currency as opposed to another currency. For instance, there is an impact on the returns from international funds if the rupee gains against the US dollar. 

It would help to diversify your portfolio across geographies for exposure to global investment themes. However, you must be mindful of taxation rules and the expense ratio before commencing your investment. In a nutshell, you must invest in international funds passively to get returns in line with foreign stock markets. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in