Indian Investors Foreign Portfolio: How to navigate the currency risks in international investing

By Aniruddha Bose

In an effort to diversify beyond Indian shores, many investors seek out international stocks as a means of spreading out risks. This may be in the form of foreign ETFs that mimic returns from specific indices like the NASDAQ 100, feeder funds that collect money under the local asset management company umbrella and deploy them into foreign mutual funds, or directly into U.S. stocks using DIY apps.

However, whatever the choice of investment vehicle, these investors do end up taking on an additional layer of risk by investing in any foreign equity market – that is, the risk that the overseas currency will depreciate, resulting in losses in the portfolio!

The next question that comes to mind is – can these risks be mitigated in any way? While these risks can be cushioned to an extent, the problem with hedging currency risks is the probability that your decision to hedge risks was wrong in hindsight!

If that turns out to be the case, you would have unnecessarily sacrificed a good deal of potential returns in your effort to protect a temporary downside. Hedging currency risk is a complex matter and typically beyond the scope of retail investors who have investable surpluses of US$ 500,000 or less (around Rs. 4 Crores).

We do believe that these investors can get all their investment needs fulfilled from the gamut of domestic funds and stocks themselves and really do not need to look beyond them.

Nevertheless, if you do hold a large position in a foreign ETF or Mutual Fund, the most effective way to mitigate temporary currency risks in your portfolio would be through selling currency futures in the currency of the stock or fund that you hold the position in (for instance, the USD in case your position is in US Stocks or a NASDAQ ETF). In order to do this, you would need to open a currency trading account with a broking platform first.

Here is how it works: say, you hold Rs. 40 Lakhs in a U.S. stock or fund and are worried about currency depreciation but do not want to sell your holdings, incur capital gains taxes (or loads), and re-invest your money later. For simplicity’s sake, let us say that the US $ is trading at Rs. 80 on that day. Since USD-INR futures are available in lots of $1000, you can sell 50 lots of $1000 each of the USD-INR pair for Rs. 40 Lakhs by depositing a small margin of around 2.5% of the trade value.

Now, if the US$ depreciates to Rs. 78, you will make a profit of Rs. 1 Lakh on this position which would offset your mark to market losses in the dollar-denominated stocks or mutual funds. The flipside of course is that if the US$ actually appreciates during this period, your profits in the portfolio will be negated by the losses in your currency futures position. Unfortunately, this is how a perfect hedge plays out – you cannot cancel risks and still benefit on the upside! In a sense, this is just like a temporary ‘portfolio insurance’ of sorts.

Another simpler strategy that does not require the opening of a currency trading account could be to balance out your US $ holdings with a position in gold, through an ETF or a gold savings fund. Since gold is predominantly dollar-denominated, its returns are generally inversely related to US$ returns. Though this is not a ‘perfect hedge’ per se, it may cushion your portfolio to an extent in case of a dramatic fall in the US $.

For most retail investors though, all these are overkills. Even if you have chosen to invest into a foreign fund, make sure you do it systematically through SIP’s or STP’s. The rupee cost averaging effect will automatically mitigate currency risks to an extent and you may even end up benefiting from the increased volatility in the long run.

We would like to conclude by saying that long term returns are rarely a byproduct of timing the market, finding the perfect hedging strategy or investing in the highest return product. In the long run, it is your investing behaviour that will make all the difference. By investing according to clearly defined goals, having a great investing process, setting the right expectations, and understanding risks properly, you will reap a lot more benefits than deploying complex investing strategies in the long term!

(Author is Chief Business Officer, FinEdge)