For mutual fund (MF) investors, the diversification opportunity just got bigger with the Securities and Exchange Board of India (SEBI) hiking the overseas investment limit of domestic fund houses by 65% to $1 billion (overall industry limit remains at $7 billion). Each MF can also invest up to $300 million in overseas exchange-traded funds (ETFs; overall limit remains $1 billion). The windows to the world have been opening rapidly. Just six months back, the fund house cap was doubled to $600 million and the ETF limit quadrupled to $200 million.

Fund houses have been quick on the uptake. As many as 16 of the 53 international schemes in the market today were launched after March 2020. So why should you consider diversification?

Because winners change every year. For instance, in the bear run of 2020, the Nasdaq Composite of the US gave an astounding return of ~44%. In stark contrast, it has gained just ~8% so far this year. See historical calendar year performance table to understand things better. Diversification helps investors ride volatility better and weather different market seasons.

For better understanding, let us look at the correlation of Indian and overseas equity markets over the past 10 years. A CRISIL Research analysis shows a weak positive correlation that varies across markets. A correlation above 0.80 is deemed strong, whereas the correlation of the S&P BSE Sensex ranges from 0.05 (versus the Shanghai Composite) to 0.53 (vis-a-vis the Straits Times Index).

Lack of strong correlation implies another index is doing well when Indian indices are not, which means investors can ride the other market’s rally as long as it lasts.