Dollar Dreams: Merits and risks of investing in US equity market

How many times have you seen a college going teenager flash an iPhone 4S, even as his eyes remain glued to his Microsoft Window 7-loaded Intel i5 Dell laptop, in the neighborhood KFC outlet? Or a young girl in a Nike outfit pulling out her Citibank platinum card to pay for a bucket of Fiery Grill chicken?

Have you ever realized how many American products and services you use in your daily life? Not just gadgets and apparel, a wide range of US products, including toothpastes, soaps and food articles, besides financial services, occupies an important place in your daily life.

There are hundreds of products and services that originate in the US and are used globally. No wonder the country is home to some of the world's biggest companies in terms of market capitalisation and brand value.

How about dressing your portfolio with stocks of US companies, which own some of the world's most well-known brands? Does it make sense to invest in US companies? If yes, is it the right time to take exposure to the world's largest market?

A couple of Indian mutual funds recently launched US equity funds-ICICI US Bluechip Equity Fund and DSP Black Rock US Flexible Equity Fund-which will invest either directly (former) or through the feeder fund route (latter). Motilal Oswal Mutual Fund already has an exchange-traded fund which invests in Nasdaq 100 stocks.

We look into the merits and risks of investing in the US equity market in the present scenario.

A CASE FOR US EQUITIES?
The US gross domestic product (GDP), which measures production of goods and services, is $15 trillion (compared to India's $1.5 trillion). This is 21.67 per cent of the world GDP. Listed companies in the US account for more than 33 per cent world market capitalisation. Between 1980 and 2010, the US markets generated 14 per cent annual compounded growth in rupee terms.

According to DSP Black Rock Mutual Fund, US equities are the core of almost every major global equity or sector portfolio/index. "On an average, US equities represent close to 50 per cent of global equity indices," it says.

A global presence helps US companies not only mitigate country-specific risks but also take advantage of growth in emerging and other economies.

"American brands and companies are significant beneficiary of any emerging market growth story; most leading American companies earn over 50 per cent revenue from non-American markets," says Sankaran Naren, chief investment officer, ICICI Prudential Mutual Fund.

The US is also one of the most diversified equity markets in the world with the top two sectors, financials and technology, accounting for only 34 per cent market capitalisation.

The US is home to some of the most innovative companies such as Apple Inc, Google, etc, which have set global trends and generated immense wealth for shareholders. Investing in the US also gives exposure to such companies.

NOW OR NEVER?
Has the US equity market recovered from the 2008 financial crisis? Some experts say the country has shown signs of economic recovery in the past couple of years. "Over the past two years, economic fundamentals have improved. The unemployment rate has fallen from 10 per cent to 8 per cent, the CEO Confidence Index has risen from 1.5 to 6 and corporate balance sheets are stronger than they have been in many years," says Rakesh Goyal, senior vice president, Bonanza Portfolio.

US stocks outperformed non-US stocks for the third year in a row in 2011-12 amid the European debt crisis. In 2011-12, the Dow Jones Industrial Average Index rose 6.7 per cent while Nasdaq gained 10.8 per cent. India's Nifty and Sensex fell 9 per cent and 10 per cent, respectively, during the period.

Recently, rating agency Fitch observed that "greater rating outlook stability was shown in US public finance, corporates and infrastructure. The weak US recovery reflects the gradual rebalancing of the economy, such as unwinding of excessive household debt and housing market correction, rather than a permanent downshift in the growth rate of the economy."

In terms of valuation, US stocks are cheaper than their long-term average. The S&P 500 index is currently trading at 13 times forward earnings against its longterm average of 16.9 times.

RISKS AND DRAWBACKS
When you invest in foreign equities, you are exposed to country-specific risks, both economic and political, tax laws as well as the risk of changing currency rates.

Despite the global presence of US companies, the impact of local economic factors cannot be overlooked completely. Though the US economy has shown resilience in the past couple of years, short- and medium-term worries exist. For instance, the unemployment rate at 8.3 per cent (up from 8.2 per cent in June) is still above the Federal Reserve's comfort level.

The US economy grew just 1.5 per cent in the second quarter as against the 2.5 per cent required to keep the employment rate stable. The country's central bank recently observed that the economy 'decelerated somewhat' in July, in sharp contrast to its June assessment that the economy was 'expanding moderately'.

Since your investments will be in securities priced in US dollar, changes in rupee-dollar exchange rates may also have an impact.

Also, one disadvantage of investing in foreign equities is that you will have to forgo the tax benefits that your domestic equity investments get. In India, long-term capital gains are tax-free. However, capital gains from foreign equities are taxed like debt instruments, that is, long-term capital gains are taxed at 20 per cent with indexation and 10 per cent without indexation. Short-term capital gains are taxed at the normal rate of income tax. Indexation is adjusting the purchase price with inflation. It reduces real capital gains and, hence, the tax liability.

Tapati Ghose, senior director, Deloitte Haskins & Sells, says, "Since no securities transaction tax is charged on sale/purchase of stocks, long-term capital gains are not tax-free in the US."

{quote}Securities transaction tax (STT) is payable on every sale and purchase of shares. The tax gets added to the price of the stock. India levies STT on equity transactions and hence longterm capital gains on equities are tax-free.

DIRECT OR MUTUAL FUND ROUTE?
Investing directly in US equities could be a cumbersome process involving issues of foreign exchange, tax laws and tracking a wide range of factors. For retail investors, these could be a big deterrent.

However, those who still want to invest in US equities can do so through an Indian broker who has tie-ups with brokers, clearing corporations and exchanges in the US. An Indian investor can make purchases overseas up to $200,000 every financial year under the Reserve Bank of India's liberalised remittance scheme.

"Many investors who want to diversify their portfolio internationally use the overseas platform offered by brokerage houses for directly investing in global equities. Executives who are working in multinational companies and are eligible for employee stock options also use their overseas trading accounts," says Vishal Gulechha, head, equity product group, ICICI Securities. The company also offers a trading platform for direct investment in overseas equity.

However, those who want to avoid the hassle of direct investment may go through mutual funds which invest either directly or buy units of mutual funds that invest in such stocks.

{blurb}"Regular tracking of foreign markets while sitting in India is not easy even for an institutional investor. Retail investors, should, therefore, invest through mutual funds, which have the necessary wherewithal and expertise to keep track of overseas markets," says Raghavendra Nath, managing director and CEO, Ladderup Wealth.

FINAL CALL
US equity markets are one of the most developed in the world and offer an opportunity to invest in some of the most respected global companies. Investing in the country's equity market can offer a good geographic diversification to your portfolio.

Investors, however, should be aware of the local economic and political risks, tax laws as well as currency market trends before taking the plunge.

Retail investors would be better off taking the mutual fund route instead of direct investment to take exposure to global securities.

Source:

Indian bonds yields little changed

Indian federal bond yields ended little changed on Tuesday as dealers preferred to stay light ahead of a central bank rate meeting and the fiscal second-half borrowing numbers later in September.

Dealers are also waiting to see whether the government will increase diesel prices, a contentious political issue, as any rise will push up freight and input costs.

The Economic Times reported on Tuesday that the government may raise diesel prices by 4-5 rupees a litre after the current session of parliament ends on Sept. 7.

While such a move will be inflationary in the near term, the central bank itself has been arguing that the government raise subsidised fuel prices to cut its bloated deficit bill.

"The key trigger will be the second-half borrowing. Overshooting is a done deal with the market expecting 500-600 billion rupees of extra borrowing," said Mahendra Jajoo, head of fixed income at Pramerica Mutual Fund.

India is scheduled to borrow 5.7 trillion rupees in the current fiscal year that ends in March, 65 per cent of which will be completed during April-September.

But the government is unlikely to stick to its 5.1 per cent fiscal deficit target, and will have to borrow more to fund any further gap.

The central bank is unlikely to provide any relief by lowering rates as it views the current inflation levels as too high.

RBI is expected to keep its key interest rate steady this month, a Reuters poll showed.

Jajoo said the bond market will also await signals on liquidity from the RBI, specifically as to when it resumes its open-market bond purchase, which it stopped in end-June.

Liquidity remains comfortable with the overnight benchmark rate or Mumbai Interbank Offer Rate slipping below 8 per cent for the first time in 11 months.

However, the cash shortage is expected to accentuate in mid-September when corporates pay advance tax, which will result in outflows to the tune of 500-600 billion rupees from the banking system.

The benchmark 10-year bond yield ended 1 b asis point lower at 8.21 per cent.

Total volume on the central bank's electronic trading platform was less than usual at 160.25 billion rupees.

The benchmark five-year swap rate was unchanged at 7.16 per cent, while the one-year rate was down 1 bp to 7.79 per cent.

Source: http://economictimes.indiatimes.com/markets/bonds/indian-bonds-yields-little-changed/articleshow/16252338.cms?curpg=2