Whalesbook
Many Indian investors are looking at global markets due to recent strong returns. However, chasing past winners often ignores the risks of concentration and market cycles. Understanding concepts like 'recency bias' and 'mean reversion' is crucial for building a resilient, long-term portfolio.
What Happened
There is a growing interest among Indian investors to include global stocks, such as those in the US or other international markets, in their portfolios. This trend is often driven by the strong performance of specific global technology stocks or indices over the last year. While global diversification is a valid investment strategy to spread risk, financial experts are warning investors to be cautious about relying solely on recent high returns when making new investment decisions.
The Danger of Recency Bias
Recency bias is the psychological tendency to believe that because an asset or market has performed well recently, it will continue to do so in the future. Investors often fall into this trap by focusing on high-performing indices or stocks without looking at the underlying risks. For instance, the MSCI Taiwan Index recently showed significant gains, but a large part of that performance was tied to the dominance of one single company, Taiwan Semiconductor Manufacturing (TSMC). If that single stock were to face problems, the entire index could struggle. Similarly, in the US market, a massive portion of the gains seen in the S&P 500 index over certain periods was driven by a small group of mega-cap technology stocks like Alphabet, Amazon, and NVIDIA. If these few companies are excluded, the broader index return looks very different.
Understanding Mean Reversion
Mean reversion is a financial concept that suggests asset prices and market returns tend to return to their long-term averages over time. It implies that extreme movements, whether up or down, are often temporary. Historically, markets that experience a rapid and dramatic surge often go through a period of correction. Some countries, such as Argentina, Turkey, and Nigeria, have seen years of spectacular growth followed by steep declines. This pattern highlights that no single market consistently beats all others year after year. The lesson for investors is that a market that looks attractive today may not be the same one that leads tomorrow.
Lessons from the Indian Market
It is important for Indian investors to remember that the Indian stock market itself has seen long periods of both growth and stagnation. For example, investors who looked at market performance between 1993 and 2003, or between 2008 and 2014, experienced years where wealth creation was flat or slow. These 'drought' periods are a normal part of the equity cycle. Just as the Indian market has gone through these phases, international markets also face long periods where returns do not meet investor expectations. Investing requires a decadal perspective—looking at progress over ten years or more—rather than reacting to the performance of the last one or two years.
Practical Risks for Indian Investors
When investing globally from India, there are factors beyond market performance that investors often overlook. First, global investing involves currency risk; if the Indian Rupee strengthens against the foreign currency, the value of the foreign investment drops in Rupee terms. Second, Indian investors must be aware of the tax implications. Foreign dividends and capital gains are taxed differently than domestic assets. Additionally, investors utilizing the Liberalised Remittance Scheme (LRS) must account for transaction costs, bank charges for remittances, and potential tax collection at source (TCS) rules, which can reduce the net return on investment. These costs and complexities make it even more important to have a clear, long-term strategy rather than simply following short-term trends.
What Investors Should Track
Instead of chasing the latest top-performing market, investors should focus on the quality of their asset allocation. The key monitorable is whether the inclusion of global assets is truly helping to diversify the portfolio or if it is simply adding exposure to the same risks. Investors may track whether their global allocation remains a small, strategic part of their overall wealth rather than a large, speculative bet. Regularly reviewing the portfolio’s goals, understanding the tax structure, and maintaining a long-term time horizon are more effective ways to manage money than attempting to time market movements based on recent news.
