Get the perfect hedge against Rupee depreciation: Invest in a Dollar-based portfolio

Vikas V Gupta
Sep 9, 2018 · 5 min read

The INR has touched 72.1 versus the USD. A year back it was at 63.94. The prevalent wisdom was that the INR would touch 58–62 range in 2018. However, one year down the line we are at 72.1. That is not a surprise. In the long run, the INR depreciates against the USD in a range of 2.5% to 6% CAGR, depending on the inflation differential and productivity growth differential.

Since India’s long-term inflation rate is around 7% and the USD long-term inflation rate is around 2%, a 5% drop annually is possible. India’s higher productivity gains make the drop lesser.

In the short-term, the demand and supply factors determine the exchange rate. In times of large FPI or FDI inflows, or high exports the INR strengthens and in times of large outflows the INR depreciates.

One of the largest items Indian imports is crude oil. Since the demand is nearly inelastic, as the crude oil prices have a very large impact on the exchange rates. As the crude prices have increased recently, it has caused a large depreciation in the INR in the near term. Of course, there are several other driving factors.

However, the fact remains that the rupee depreciates over the long-term.

How to Benefit From a Depreciating Rupee?

The Scientific Investor tries to explore ways of benefiting from events it cannot control rather than complaining about them. How can we position our portfolio to benefit from the declining rupee?

The perfect hedge against a depreciating Rupee is a Dollar-based portfolio.

One way of getting this perfect hedge is to invest in a Dollar-based portfolio. This can be accomplished in two different ways. One way is to invest in companies listed in the US markets. An investment in these companies appreciates in Rupee terms whenever the Rupee depreciates. We have been consistently discussing this earlier in several publications; see here, here and here.

A global portfolio helps both in giving exposure to a different economy, different sectors and completely different kind of stocks. The exposure to Developed economies gives support to the portfolio in times of crisis. Further, there are several sectors which are missing in the Indian stock markets. Additionally, the portfolio could get exposure to thematic ideas such as Artificial Intelligence.

An investor could easily have taken exposure to the US markets and S&P 1500 stocks with OmniScience’s US Supreme portfolio. Such a portfolio would have an additional return from the Rupee depreciation over and above the Dollar-returns of the portfolio. A more risk-averse investor might have taken exposure to the US large caps chosen by the Greatest Investor, i.e. Warren Buffett, himself. OmniScience’s Greatest Investor Portfolio (GIP) would have given exposure to a portfolio which selects from within the listed equity portfolio of Berkshire Hathaway. Scientific Alpha is used to create a portfolio which selects the most undervalued stocks from a list of stocks with the seal of approval of Warren himself!

Additionally, an investor could also have taken exposure to interesting themes such as Artificial Intelligence and Internet of Things (AI and IoT) with the AIoT portfolio, i.e. the OmniScience Artificial Intelligence portfolio.

While the above is a near-perfect hedge, this is sensible fine for a sophisticated, high-networth investor, a normal retail investor could have taken exposure to the Dollar through listed firms on the Indian stock market too.

One of the easiest way is to invest in companies which sell in dollars and spend in rupees. These are companies whose customers pay in USD, but they pay their employees and suppliers, primarily, in INR. Simply, put invest in export-oriented companies.

Of course, one cannot blindly invest in any export-oriented company. One should focus on the fundamentals first. Is the company profitable even when then INR is strong? Maybe the profits are lower, that is acceptable. But it should not go into losses when INR becomes strong, which from time to time it will. The company should have a strong balance sheet with low or zero debt. The company should be capital efficient. Finally, the company should be available at a large discount to intrinsic value. In short, we have just described an exporter which fits the Scientific Alpha selection process. This means that it is a SuperNormal Company available at a SuperNormal Price. One can invest in a portfolio of such companies to have a robust hedge against the INR depreciation in the long run.

Of course, from time to time the Scientific Alpha (Exporters) portfolio should be reviewed for overvaluation or fundamental deterioration. However, if the overall portfolio remains fundamentally strong and is not overvalued, it can continue providing a hedge against the INR depreciation. In fact, it could gain substantially as INR depreciates.

The Scientific Alpha Multicap Portfolio (Indian Supreme) already includes several exporters in it. However, ideally, a specific pure exporter portfolio should be allocated to on a permanent basis. Possibly, this could be around 20–25% of one’s total capital.

A properly positioned portfolio would have gained from such an allocation. The Scientific Alpha Multicap Portfolio has seen the benefits of its allocation to the export-oriented IT sector. It benefited from the INR depreciation. It further benefited fundamentally through an exposure to the strong US economy. Further, the most important factor which is still not priced in fully in the IT sector is the fast-growing Digital Transformation portion of the business which forms more than 25% of the revenues of most mid-to-large IT companies. The Digital Transformation portion of the revenues is growing in the range of 25–35% CAGR. That part of the business is still not discounted in the prices.

However, the perfect allocation would have been a portfolio with exposure to all Global markets. An ideal portfolio allocation for an HNWI, sophisticated and aggressive investor is 60% India Supreme, 20%-30% spread across Global Allocator (a predesigned exposure to the US, EU, UK and JP markets) GIP and US Supreme, and 10% AIoT or other thematics.

However, while investing in any sector or theme, always keep the Scientific Alpha investment framework in mind and only invest in SuperNormal Companies at SuperNormal Prices!

Dr. Vikas V Gupta, CEO and Chief Investment Strategist, OmniScience Capital

www.omnisciencecapital.com

Read more OmniViews here http://bit.ly/2Mhym1D

Disclaimer:

Past performance is not necessarily indicative of future results.

Omniscience Capital Advisors Private Limited (Omniscience Investment Advisers) is a Registered Investment Advisory firm with SEBI-registration no. INA000007623. Equity investments are subject to market risks. Please read all investment related documents carefully. An investor should consider the investment objectives, risks, and charges & expenses carefully before taking any investment decision. This is not an offer document. This material is intended for informational purposes only and is not an offer to sell any services or products or a solicitation to buy any securities. Any representation to the contrary is not permitted. Omniscience makes no warranties or representations, express or implied, on the products and services offered. It accepts no liability for any damages or losses, however caused, in connection with the use of, or on the reliance of its product or services. This document does not constitute an offer of services in jurisdictions where the company does not have the necessary licenses. This communication is confidential and is intended solely for the addressee. This document and any communication within it are void 30-days from the date of this presentation. It is not to be forwarded to any other person or copied without the permission of the sender. Please notify the sender in the event you have received this communication in error.

We may have recommended stocks, or stocks in the mentioned sectors to clients, including having personal exposure.

OmniView

OmniView presents a Value Investor’s perspective on businesses, companies, economies and markets. It provides an original insights from OmniScience Capital, a global investment management firm with strong philosophical roots in the value investing philosophy of Graham and Buffett

Vikas V Gupta
OmniView
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