How to gain from a depreciating rupee

The rupee has weakened sharply against the dollar in 2008, 2013 and year-to-date in 2018

One macro risk that gives Indian investors many sleepless nights is a depreciating rupee. When the rupee sinks against the dollar, it stokes domestic inflation, hurts the earnings of companies that use imported inputs and dents returns for foreign investors, causing them to flee Indian markets. The rupee has depreciated against the dollar in 13 of the last 20 calendar years and has lost an average of 2.7 per cent every year. If you have regular dollar expenses, such as those of children studying abroad, you are hit harder by this risk.

So, as an Indian investor, can you actually make money on some portion of your portfolio when the rupee sinks? There could be three routes to do that.

Stocks of exporters

Companies in export-dependent sectors such as information technology and pharma receive a lift to their revenues when the rupee depreciates. But while short-term traders often take a punt on IT or pharma stocks to play a weak rupee, in the long run, these stocks haven’t proved great hedges.

In the past decade, the rupee weakened sharply against the dollar on three occasions — 2008 (depreciated 19 per cent), 2013 (slid 11 per cent) and on a year-to-date basis in 2018 (down 13 per cent). The stock market fell sharply in 2008 (Sensex down 52 per cent), and made low returns both in 2013 (9 per cent) and year-to-date 2018 (3 per cent).

The BSE IT Index has beat the Sensex to post a 31 per cent gain in YTD 2018 and a 55 per cent gain in 2013. But IT stocks haven’t really proved immune to big bear markets. In 2008, the BSE IT Index lost 52 per cent, same as the Sensex.

Pharma used to be the quintessential defensive sector, but its earnings prospects have lately been undermined by US regulatory crackdowns and stiff price erosion. In YTD 2018, the Nifty Pharma Index has underperformed the Sensex with just a 2 per cent return.

Gold ETFs

Since India imports almost all of its gold requirements, domestic gold prices faithfully mirror international prices in dollar terms. Returns on domestic gold holdings, therefore, perk up every time the rupee depreciates against the dollar.

Owning gold in your portfolio would have lifted its performance both in 2008 (gold prices in rupees was up 26 per cent) and 2018 (up 8 per cent), but it wasn’t of much a help in 2013.

The fall in international gold prices that year offset the gains from rupee depreciation. Gold is also not a high-return-earning asset in the long run.

Therefore, you can own gold to diversify against rupee risks, but restricting it to 5-10 per cent of your portfolio makes sense.

If buying gold as a diversifier, gold ETFs and sovereign gold bonds are more efficient than physical gold or jewellery.

Foreign mutual funds

Indian mutual funds that own stocks listed overseas offer a possible avenue to cushion against rupee depreciation. Such funds earn you returns from two sources — the earnings of companies listed overseas and the returns from the dollar strengthening against the rupee.

Indian AMCs today offer nearly 40 funds that invest either part or whole of their portfolio in stocks listed overseas. These come in a variety of shapes and sizes. Some track specific regions such as the US, Europe or emerging Asia, while others invest in countries such as Japan, Brazil or China or asset classes such as real estate, renewable energy and gold.

Of this bunch, emerging market funds have, however, displayed a high correlation with India, defeating the objective of diversification.

Mining, commodity and real-estate funds are highly volatile. The only category of foreign funds that has proved a really good bet on rupee depreciation is the ones investing in US stocks, which gain both from the performance of the companies listed there and from the dollar appreciation. An investor who simply bought the US S&P 500 and translated her returns into rupees would have experienced a 24 per cent loss in 2008 (less than half the Indian market’s fall), while earning positive returns of 46 per cent in 2013 and 21 per cent for YTD 2018.

This makes US-centric feeder funds such as ICICI Prudential US Bluechip Equity Fund, Franklin India Feeder US Opportunities Fund and Motilal Oswal Nasdaq 100 ETF the top options for those looking to make money off rupee weakness. You can look to park 10-15 per cent of your equity portfolio in such funds via SIPs.

Earlier, investors used to shy away from foreign feeder funds because they were treated like debt funds for tax purposes, while domestic equity funds enjoyed zero long-term capital gains tax.

But with domestic equity funds now subject to LTCG tax at a flat 10 per cent, this tax difference has been whittled down.

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