Rajeev Thakkar is the Chief Investment Officer and Director at PPFAS Mutual Fund. At the Morningstar Investment Conference in October 2021, I engaged with him regarding his views on global investing.
Indian investors have traditionally exhibited strong home bias despite Indian equities cornering a miniscule 3% of global market capitalization. Is the home bias making individuals poorer as they miss out on opportunities?
I would like to rephrase the statement "Is home bias making you poorer?" to "Is home bias making investors lose sleep at night?" Because to my mind, the primary driver for international diversification should be reduction of country-specific risk rather than the chase for higher returns. Because when it comes to returns, people can argue either ways, saying India is the emerging market and opportunities here are good enough, why go outside India. So, it says that diversification is the only free lunch in investing, and by only investing in India, probably investors are giving up more than 90% of the opportunities which are available globally.
The other myth that is propagated very often in this space is that only the ultra-rich or the very wealthy should embrace global diversification. I'll argue that, in fact, even smaller investors benefit a lot from the wider opportunity set and the mitigation of country-specific risk. So, global equities should be part of every equity investor's portfolio rather than looking at it as something which is niche, and which is targeted only at the ultra-wealthy.
When investors do venture into global markets, oftentimes the only port of call is U.S. equities. You have a strong exposure to that geography too.
When looking at whether one should have U.S. as the port of call or the developed countries, or whether one should look at emerging markets as a basket, here's my personal view. While one should embrace international investing, at least in the initial stages, one should not be too adventurous, because many of the emerging markets don't have the robust legal systems or the corporate governance systems. And in the initial stages, at least one should stick to a market like U.S. or maybe North America, Western Europe and developed Asia as markets to invest in. Firstly, because companies listed here have global operations and you also benefit from emerging market growth by investing in these markets. And you also avoid some of the sudden death kind of scenarios where if the governance is not that strong, you could see severe drawdowns in the portfolio.
Once you decide to invest in global markets are fund-of-funds the most viable route? Or must LRS be embraced?
That depends on individual preference. But when one is going to the LRS route, one should be mindful of the taxation impact, estate duty in the U.S. markets and things like that. So, yeah, we could delve on these topics further in our discussion.
You've been investing in global markets through your flexi-cap fund for a while now. What value are you able to see in terms of sectors or stocks that you're able to add into your portfolio through this global diversification vis-à-vis, say, an India-only kind of strategy or a fund that you would otherwise run?
One great thing about India is that it's a well-diversified market in terms of lots of listed companies covering a whole gamut of sectors. So, we have the commodity plays, we have banking and financial services play, we have IT services, pharmaceutical exporters and all of that. But still the point that Dan was making that no single country will offer you all sectors. So, for example, we may not have the semiconductor manufacturing companies, which would be in a country like, let's say, Taiwan; or we would not have the EV plays like Tesla; or we would not have the Googles and Amazons and Facebook kind of companies in India. So, when we go abroad, we are able to identify the gaps that are there in the Indian market and the opportunity set which is not available to Indian investors, and we are able to fill those gaps with foreign companies.
Also, you have to look at the valuation differential. And today, when we live in a globalized world, a Wipro, Infosys or TCS would be very comparable to Accenture or a Cognizant in the developed countries, and one has to look at both these set of companies to really see where the opportunity lies. So, that's really what we bring to the table when we look at international companies in addition to the Indian companies in our portfolio.
You seem to be a strong believer in global diversification. But looking at your flexi-cap fund, it's more of an India and U.S. fund. Why not look at 100% kind of a global fund?
Multiple reasons for that.
Firstly, the funds which are characterized as Indian equity funds, where a minimum of 65% of the fund corpus is invested in Indian equities, has a beneficial tax treatment in India. So, 100% foreign fund will not get the same kind of tax treatment.
Secondly, if someone were to look at 100% foreign fund, then there are plenty of choices even from, let's say, developed country funds. So, one could remit money via LRS and invest with a U.S.-based fund manager, where really the differentiation would not come from our end. What we are looking at is, we are looking at the portfolio construction as a whole where we are trying to blend the best of both the markets. If someone is looking at specific country, specific exposures, there are alternative routes. And also, currently, the outward remittance for mutual fund houses is capped at $1 billion per fund house. So, I think we are better off utilizing that $1 billion for flexi-cap kind of fund rather than spreading it across various funds investing abroad.
You've been a big fan of the big tech companies in the U.S. They comprise about 28% of your portfolio. Given that they've had such a stellar run over the last several years, what are your views on these companies? Valuations have moved up. How do they fit into your thesis as a value investor?
One can argue both sides on this.
One can say that these are very, very large companies, and the entire U.S. market is now concentrated in, let's say, top 8 to 10 companies, and they have disproportionate share of market cap in the market as compared to history. So, obviously, these are trillions of dollars' worth of market cap, and increasingly, there's a regulator scrutiny and antitrust action and stuff like that. So, those are the risks that one has to be cognizant of.
At the same time, I would argue that this is definitely not late 90s kind of valuation in absence of cash flow or profits. So, if you look at the kind of growth numbers that you are seeing in terms of the corporate profitability or the cash flows that these companies are showing, one could also argue that these are extremely attractively valued at this point in time. And just to make a case, some of the valuations of, let's say, companies like Facebook or Alphabet or Microsoft would be cheaper on price/earnings multiple basis as compared to some of the mid-cap IT names that we are seeing in India.
So, one can argue either side. It's just that one has to be invested while at the same time be cognizant of the risks and be aware of the environment in which these people are operating. So, I definitely see a probability where some of these larger companies could spin off some of the businesses just to be seen as not too big or not too dominant in their own area of operations and thereby, taking off some of the regulatory pressures that they are seeing.
One difference in the current scenario as compared to the earlier scenarios was that, let's say, taking the example of Microsoft and the dominance in the desktop operating space in the past, this time around, there are two or three players competing. So, one can argue that the Android operating system and the iOS are not monopolies and at least you have two companies competing in that space. So, it's not like that one company has a monopoly. But still, yeah, one has to be mindful of the sheer large size that these companies are at.
How much does the international investment in the flexi-cap fund contribute to the returns of the fund?
Surprisingly, for most investors, the Indian component for us has done better than the foreign component. But the foreign component has beaten the S&P 500. Although it's beaten the NASDAQ, since some of the tech companies are more of a recent vintage. But both the Indian component and the foreign component have beaten their respective indices, which is Nifty 500 here and S&P 500 in the U.S.
The time frame I'm referring to is the return since inception, which is the 8-plus year that the fund has been around. (A reminder that this discussion took place at the Morningstar Investment Conference in October 2021).
What percentage of your personal portfolio would you invest into outside your home country, and which would be the preferred country?
20%. The U.S. market.
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