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Investment tip: Merits and risks of investing in US equity market

Investment tip: Merits and risks of investing in US equity market

You can diversify your portfolio to include funds that tap the world's largest economy. We look into the merits and risks of investing in the US equity market in the present scenario.

How many times have you seen a collegegoing teenager flash an iPhone 4S, even as his eyes remain glued to his Microsoft Window 7-loaded Intel i5 Dell laptop, in the neighbourhood 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 realised 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 wellknown 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 BlackRock US Flexible Equity Fund-which will invest either directly (former) or through the feederfund 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.

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 BlackRock 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.

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.

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."


American companies are significant beneficiaries of any emerging market growth story.

Vishal Gulechha

Head, Equity Product Group, ICICI Securities

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.

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.

Taxing Issues

  • Capital gains by a mutual fund from listed US stocks will be tax-free in the US provided the fund holds 5% or less of any stock.
  • If the holding in a publiclytraded company is more than 5%, gains from such sales are subject to corporate tax up to 35%.
  • Dividends received by a mutual fund from investments in US-listed equity are subject to 30% withholding tax.
  • Capital gains made by a mutual fund from sale of US Treasury bills, notes or bonds are not taxed in the US.
"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.

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.