Are domestic investors leveraging opportunities in international markets enough? Let’s contextualize this with a data point. Did you know that global investments of domestic investors account only for 0.50% of total investments?¹ A missed opportunity?

Currently, while there are some avenues to invest in international stocks either directly or through mutual funds, the opportunities to invest in international debt are limited. At a time when rising interest rates are making debt investments look lucrative, and there are significant opportunities in international debt especially that of U.S. markets, the avenues are few.

Investing in global markets can provide a holistic portfolio diversification, helping to minimize equity market fluctuations. One such avenue is investing in U.S. Treasuries which offer a way to build a USD asset.

U.S. Treasury – an attractive investment option?

Post the pandemic, both fiscal and monetary authorities responded with unprecedented levels of stimulus to support a quick economic rebound. Perhaps, they were emboldened by decades of low and stable inflation and the post-GFC (Global Financial Crisis) experience when inflation stayed low despite an aggressive response back then. As it turned out, inflation came back with a vengeance as supply side issues triggered by the pandemic met strong demand from stimulus-fed households who had already de-levered over the last decade. The rebound in inflation turned out to be anything but transitory. To counter this, what followed was the most aggressive pace of rate hikes we have seen from Developed Economies. The Fed has already hiked interest rates by 525 basis points² (as of July 2023 since the rate hike cycle in March 2022) At this moment, growth has proven to be remarkably resilient and therefore markets aren’t being able to price in a large number of cuts which has led to higher yields across the yield curve.

However, we have now started to see signs of lower inflation sequentially as supply chain issues caused by the pandemic have healed to a large extent, commodity prices have also cooled off meaningfully from the post-war levels and the labour market, while still tight, is showing signs of cooling off as wage growth and labour demand have fallen significantly from the highs. The Fed has also indicated that they are close to the end of the rate hiking cycle³. Monetary policy works with lags and as these hikes work their way through the system, we should see lower inflation and rate cuts on the horizon. Multi-decade high Fed rate and potential for expected rate cuts in FY24 have created an attractive opportunity in US Debt investment.

a. Such high rates tend to cause economic disruption and demand destruction. Ultimately central banks resort to monetary loosening (rate cuts) to revive the economy. This should happen in US as well in CY24/25 – an opportunity for capital gains.

b. Till such time rates remain high, along with a credible and significantly higher credit rating, it presents a great opportunity to lock in higher rates (pretty much what has happened in India over the past 2 years).

c. Since India is an emerging market with a weaker currency, we have historically seen a depreciating rupee against the US dollar (5.07% p.a. depreciation over the last 15 years)⁴ – potential to add to gains from currency as well.

d. An additional important point to note is that such high rates and massive dislocation in yields are rare and have happened only a few times in the past 40 years. It is this set-up and the Goldilocks moment that makes this opportunity so unique and compelling.

Four-dimensional diversification with investment in U.S. Treasury

Issued by the U.S. Govt. to finance spending needs, U.S. Treasury securities are considered among the safest investments in the world due to the creditworthiness of the U.S. government. The U.S. Treasury market is one of the largest and most liquid bond markets globally⁵. Access to it, allows investors to potentially benefit from the stability and liquidity of U.S. government debt securities.

Investing in International Investment Grade Debt Securities provides improved diversification.

• Asset Class Diversification: Focusing on economic growth with expected rate reductions, investing in debt securities may yield better capital gain returns.

• Risk–Off Profile: Investors favour stronger economies and currencies during global uncertainty, increasing flows to U.S. debt markets. This creates a hedge against EM (Emerging Market) Equity downside in black swan events.

• Currency Exposure: Create a USD/INR currency hedge by investing in USD-denominated assets and protect against INR depreciation. Holding exposure to USD can be a good hedge against future USD expenses/liability and protection against depreciating INR.

• Geographical Exposure: Enhance risk-adjusted returns by avoiding home country bias and diversifying into U.S. Sovereign securities.

In addition, relatively better yields are available on a risk-reward basis in terms of rating differentials with India at ‘BBB-‘rated compared to the U.S. at ‘AA+/Aaa’. Typically, U.S. Treasury trades at a lower yield than the Government of India debt paper, but the gap has narrowed to decadal lows. A lower yield differential provides a good opportunity to invest in US treasuries.

The views expressed in this article are for knowledge/information purpose only and is not a recommendation, advice, offer or solicitation of business or to buy or sell any securities or to adopt any investment strategy. Aditya Birla Sun Life AMC Limited (“ABSLAMC”) /Aditya Birla Sun Life Mutual Fund (“the Fund”) is not guaranteeing/offering/ communicating any indicative yield/returns on investments. The sector(s)/stock(s)/issuer(s) mentioned do not constitute any research report/recommendation of the same and the Fund may or may not have any future position in these sector(s)/stock(s)/issuer(s). ABSLAMC has used information that is publicly available including information developed in house. Information gathered and material used in this document is believed to be from reliable sources. Further the opinions expressed and facts referred to in this document are subject to change without notice and ABSLAMC is under no obligation to update the same. Further, recipients of this report shall not copy/ reproduce/quote contents of this document, in part or in whole, or in any other manner whatsoever without prior and explicit written approval of ABSLAMC. Past performance may or may not be sustained in the future. Recipients of this material should exercise due care and read the scheme information document (including if necessary, obtaining the advice of tax/legal/accounting/financial/other professional(s) prior to taking of any decision, acting or omitting to act.

1: Source: AMFI (Data as on August 31, 2023)
2. https://seekingalpha.com/news/3991413-federal-reserve-hikes-rate-by-25-basis-points-to-highest-level-in-22-years
3. https://economictimes.indiatimes.com/news/international/world-news/us-fed-hikes-interest-rates-by-25-bps-says-some-additional-tightening-possible/articleshow/98923232.cms?from=mdr
4. Bloomberg, Data as on 29th September 2023
5. https://www.fitchratings.com/entity/united-states-of-america-80442210
Other sources: ABSLAMC Research

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.