The concept of diversification is widely recognized in the investment world. It typically encompasses two primary dimensions:
- Diversification across asset classes – such as equities, debt, real estate, and gold.
- Diversification within an asset class – for example, within an equity mutual fund portfolio, this might involve selecting funds across large cap, mid cap, small cap, multi cap, or sectoral categories. In a stock portfolio, it entails holding securities across various sectors, industries, market capitalizations, and investment styles such as growth, value, or dividend-paying stocks.
However, there exists an often-overlooked aspect of diversification: geographical diversification.
Investors frequently exhibit a pronounced bias toward their domestic markets – a tendency that is understandable yet carries significant implications. In many instances, a substantial portion, if not the entirety, of an investor’s portfolio is tied to their home country’s economy. This concentration represents a considerable risk exposure, one that hinges on the performance and stability of a single geographic region.
Understanding Geographical Risk: A Practical Illustration
Consider the following scenario: An investor has diligently applied diversification principles. Their portfolio is divided into multiple asset classes – equity, debt, real estate, and gold – each containing its respective components. The equity allocation includes direct stocks, and equity funds; the debt portion comprises Provident Funds, debt funds, and fixed deposits (FDs); and the gold segment holds SGBs, and gold ETFs.
On the surface, this appears to be a well-diversified portfolio, both across and within asset classes.
Yet, all these assets are situated within a single economy – metaphorically, they rest on one table. Should that table collapse due to an economic downturn or systemic shock, every asset class, regardless of its individual diversification, would be adversely affected.
This is the essence of geographical risk: the vulnerability inherent in concentrating investments within a single country.
This risk, while tangible, is not one that investors confront daily. More immediate concerns—such as managing personal finances or addressing routine obligations—often take precedence. Even when aware of geographical risk, investors may hesitate to diversify internationally due to practical barriers: insufficient time or expertise to research foreign markets, apprehension about currency fluctuations, or the perceived complexity of cross-border transactions.
A common counterargument that most Indians give: why diversify globally when India offers such compelling growth prospects? India’s economy, driven by robust domestic consumption, is poised for sustained expansion, potentially spanning decades. Few nations present comparable opportunities, a fact underscored by the consistent inflow of foreign investment. This optimism fuels a reluctance to allocate capital abroad, as the opportunity cost of missing out on India’s growth appears prohibitively high.
While this perspective holds merit, it must be tempered with a critical acknowledgment: exclusive reliance on one country introduces significant risk, akin to the earlier table analogy.
Despite the favorable outlook for India’s markets over the coming decades, unforeseen disruptions remain a possibility. Economic derailments – whether from predictable challenges or rare, high-impact “black swan” events – can occur.
Geographical diversification serves as a mitigating strategy, reducing exposure to such risks. The objective of international investing is less about pursuing superior returns abroad and more about enhancing portfolio resilience through geographic balance.
Historical data supports this approach. Indian markets, alongside other emerging markets, do not consistently outperform; there are years when developed markets surpass them. Global markets often exhibit asynchronous movements, or at least varying degrees of correlation. A modest international allocation can thus provide a buffer against underperformance in Indian equities, companies, or the rupee, while also unlocking opportunities unavailable domestically.
To illustrate an additional layer of complexity in global investing, consider a hypothetical example involving currency risk – which has the potential for returns to be eroded – or enhanced – by shifts in the relative value of the home and foreign currencies, particularly if the latter depreciates.
Notably, advancements in financial technology have reduced some barriers to international investing. Traditional banks once dominated cross-border money transfers, imposing high fees. Today, money transfer companies offer significantly lower rates, as evidenced by rate comparison platforms, thereby lowering the cost of capital movement for sophisticated investors.
Also, many investors with comparatively larger portfolios are known to use forex markets to hedge or rather hedge their domestic investments via international routes. Via CFD trading, they often get access to many financial markets and asset classes.
This is more suited for those traders who wish to diversify their trading strategy and access world markets with ease. And while the leverage option is available, let’s not forget that leverage is a double-edged sword. So, the risk of increased losses due to leverage means that traders have to enter the market with a clear strategy and a sharp sense of risk management rules.
How Much International Exposure?
There is no universal prescription for the optimal level of international exposure; the appropriate allocation varies by investor profile.
For younger or middle-aged investors with smaller portfolios, the priority should be establishing a solid financial foundation – organizing personal finances, investing consistently toward specific goals – rather than pursuing geographical diversification. The incremental benefit of international exposure may be minimal at this stage, despite objections from diversification purists.
Conversely, for high-net-worth or sophisticated investors, the calculus shifts. Beyond maximizing returns, these individuals focus on downside protection for their substantial portfolios. Allocating a modest portion – typically 10% to 15% – to international markets that exhibit low correlation with India’s economy can enhance stability. When domestic markets falter due to localized factors, international holdings may offset losses to some extent, providing a counterbalance.
This approach assumes a portfolio already includes well-diversified, high-performing domestic equity funds. In such cases, international equity exposure serves as a complementary layer
Nevertheless, for sizable portfolios, a limited allocation to global equities is a prudent step in the diversification process. It is not a bet against the home country, but a safeguard against the inherent and chaotic uncertainties of a single-market focus. Just like with any other financial decision, knowledge and preparation are key. So, if you are thinking of this path, you should dedicate some time to exploring the nuances of that path and developing a strategy in line with your investment and financial goals.