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How to Handle The Potential Impact of a War with a Strategic Mutual Fund Portfolio

Jun 23, 2020

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Last week, the nasty face-off between Indian and Chinese army in the Galwan Valley sent shivers down the spine of many. This was the first face-off of this kind between the world's two most populous nations in the last 45 years.

Despite walking an extra mile to have a cordial relationship with China post-independence (Remember a slogan: Hindi-Chini Bhai Bhai?), India's neighbour chose to backstab it considering World's largest democracy as a threat to the dragon rule in Tibet.

India shares a border of 3,488 kilometres with China and the dispute between two Asian neighbours isn't new. The tensions between the two nations this time are certainly escalating. The situation can quickly slip out of control.

Are these early indications of an Indo-China war?

At the moment, no defence expert is expecting a full-blown war, but India seems to be learning from its past mistakes.

The message of the Indian government is loud and clear: "Whether it is deployment, action, counter-action... air, land or sea, whatever our armed forces have to do to protect our country, they will do."

Amidst rising tensions, India recently has decided to buy 12 Sukhoi and 21 MiG-29 fighters from Russia. Prime Minister, Narendra Modi highlighting the capabilities of the Indian Army, has given a free hand to the army to handle the situation on ground zero. And in the last 24 hours, the Indian Army has changed the rules of engagement along the LAC which earlier disallowed neither side to use firearms and open fire on the other (as per the agreement signed in 1996 and 2005). The new rules now allow and empower the field commanders with the sanctions to use firearms under "extraordinary circumstances".

The Chinese have been quick to react to the change in rules of engagement along the LAC. Hu Xijin, the Editor-in-Chief of the Chinese government's mouthpiece Global Times tweeted, "If true, this is a serious violation of agreement & the Indian side will pay a heavy price for any such action."

What may have upset China?

Perhaps, India welcoming Dalai Lama didn't go down well with China. Therefore, shunning the "peaceful co-existence" agreed in 1954, China waged a war in October 1962, when the Indian side was confident that it won't.

What's been the trigger this time?

Aksai Chin, a disputed border area which China took under its control in 1957 by evading 38,000 sq. km of area is the main bone of contention, and so is a part of Arunachal Pradesh.

Perhaps Beijing suspects India will become aggressive on issues it had taken a softer stance on for decades.

The last few years have been different for India with nationalism at fore. India not only declared Ladakh and Kashmir as Union Territories but also built nearly 4,000 km-long road along India-China border-developments China perhaps never expected post-1962.

Moreover, China's Belt and Road initiative (BRI), also known as China-Pakistan's economic corridor [which goes through the areas of Gilgit and Baltistan in Pakistan-occupied Kashmir (PoK)] poses a concern to India's sovereignty and territorial integrity, is also a factor.

BRI has been China's prestige point since it could create a global growth engine by connecting South East Asia, Europe, and Africa closer together, which could enable the dragon nation to be a superpower in world trade and commerce.

India boycotting the BRI was a serious blow to China, since India was not only the world's fifth-largest economy then, but also has been situated at a strategically important position on the BRI map.

India's newfound aggression has made Beijing uncomfortable. And recently, the growing cooperation between India and the US, particularly after President Donald Trump's strict policy against China has added fuel to the fire.

A fact to note is, China has border disputes with almost all its neighbouring countries, except North Korea. However, of late, China seems to have adopted an expansionary policy with smaller nations who share borders with India viz., Pakistan and Nepal. While China's high-stake investments in Pakistan are well-known, it recently jumped in Nepal's internal politics and saved the communist party government. Weeks later, Nepal's government approved a new map stating a claim on some of India's territory.

China has been notoriously luring many other smaller nations in the name of its pro-developmental agenda; extending massive credits and later seeking unreasonable favours. A few years ago, Sri Lanka had to lease Hambanthota port to China for 99 years, for not being able to repay the loan. That's not just the one-off incident. China owns 1/3rd of government debt of the entire African continent.

On this backdrop, India recently banned the entry of Chinese capital through the automatic route. It also scrapped contracts of Dedicated Freight Corridor Corporation of India Limited (DFCCIL) awarded to China.

Recently, 184 nations backed India to attain a non-permanent seat in the United Nation's Security Council (UNSC). It's noteworthy that China has been historically blocking India's appointment as a permanent member of UNSC. Interestingly, Australia backed India for permanent membership of UNSC and reiterated its commitment to civil nuclear cooperation.

And last month India along with 61 other nations, supported Australia-EU-led joint movement demanding an independent probe into coronavirus outbreak. This has drawn sharp reactions from China.

Overall, anti-china sentiments are growing amongst nations that China managed to muzzle by its economic power.


(Image source: freepik.com; photo courtesy master 1305)

Is a full-blown war possible?

China's aggression and overbearing foreign policies haven't gone down well with several nations. The coronavirus pandemic has tarnished China's image globally. The second wave of coronavirus emanating from Beijing, China is reported and has spread to nations (such as the US, Japan, South Korea, Iran, New Zealand, among others).

In such times, a full-blown war, where even other nations participate, looks a remote possibility. At present, when there is a stack of economic loss caused by a coronavirus already, no nation can afford a war.

But if the situation becomes a lot worse and both nations decide to go to war, it would have ramifications on the economy and the Indian equity market. Given the tense situation, investors must be prepared for high market volatility. In the 1962 war, India's economy, the Indian equity markets dropped -16% and gold -30% as a consequence of war, according to the Business Standard which quotes RBI's 1963 Annual Report.

Looking at the present market rally, it seems markets don't expect any major escalation at this juncture. That said, strategically structuring the equity portfolio and tactically allocating to gold (as a hedge or safe haven) would help you, the investor; deal with the war-like crisis better.

Although gold can remain volatile during war times, it's a proven track record of preserving investors' wealth. And when investing in equity, you must have a long-term horizon of 7-8 years. Given that the Indian equity market has noticeably corrected since its peak, there is a decent margin of safety, and from a global viewpoint, India is looked up to as a promising investment destination. So, if your risk profile permits, take some calculated risk and build a strategic portfolio of equity mutual funds.

India is accommodative in its policies, carrying out reforms, and encouraging other nations to invest. India would receive support from all corners of the world if China decides to wage one more war against India.

How to create a strategic portfolio?

Create a strategic portfolio based on the 'Core & Satellite' approach to investing. The term 'Core' applies to the more stable, long-term holdings of the portfolio, while the term 'Satellite' applies to the strategic portion that would help push up the overall returns of the portfolio, across market conditions, especially when markets are expected to be extremely volatile.

The 'Core' holding should comprise around 65-70% of your equity mutual fund portfolio and consist of large-cap fundmulti-cap fund, and a value style fund. Whereas, the 'Satellite' holdings of the portfolio can be around 30-35% comprising of a mid-cap fund, a large & mid-cap fund, and an aggressive hybrid fund.

The 'Core & Satellite' approach aids in diversification across categories and investment styles, thereby reducing the risk to your portfolio. It can provide a cushioning during the downside in a bear phase and outperform during a bull phase. If your portfolio is strategically placed, there will be no need for constant churning of the portfolio and will be well placed to tide over the market volatility.

If you wish to invest in a readymade portfolio of top recommended equity mutual funds based on the 'Core & Satellite' approach to investing, I recommend that you subscribe to PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025 (2020 Edition)". This premium report will help you build your optimum mutual funds portfolio for 2025 without any effort on your part. If you haven't subscribed yet, do it now!

To hedge your portfolio from the adversities of war and economic uncertainty, don't forget to allocate around 10% of the entire investment portfolio to gold.

Happy Investing!

Warm Regards,
Rounaq Neroy
Editor, Daily Wealth Letter

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