3. Does international diversification still make sense in the post-GFC era?
4. What is the fundamental risk exposure of a global investment fund?
Historically, globally diversified portfolios have dominated domestic-only ones on the efficient frontier. Compared to a domestic-only portfolio, a global portfolio should earn a higher return for the same level of risk and take less risk for the same level of return. But today, many investors feel anxious about investing internationally, the result of relatively poor market performance outside the US this past year.
In 2011, global (ex US) equity markets were down about 15%. The US market was the only major market that was positive: +2.1% for the year, as measured by the S&P 500 Index. In essence, except for the US, other global regions suffered significant drops in equity valuations. Thus, an investor’s portfolio that was diversified globally underperformed domestic equity markets (US- only portfolio) in 2011. This was, however, one of the few times over the past decade that global diversification did not add value as compared to US- only portfolios, and it hasn’t changed Gerstein Fisher’s long- term belief in the merit of maintaining a globally diversified portfolio.
The Rationale for Going Global
It is rare to find any single market that has consistently performed among the top global stock markets. Since it is nearly impossible to predict which market will be a top performer in a given year, we think it makes eminent sense to hold a portfolio that’s diversified across a number of countries. Moreover, the independent movement of global markets, which react to factors such as different domestic monetary and fiscal policy cycles, has historically provided considerable diversification benefits when held in combination with US investments (though correlations tend to converge on 1 in periods of financial crisis).
Historically, globally diversified portfolios have dominated domestic-only ones on the efficient frontier. Compared to a domestic-only portfolio, a global portfolio should earn a higher return for the same level of risk and take less risk for the same level of return. But today, many investors feel anxious about investing internationally, the result of relatively poor market performance outside the US this past year.
given the lower correlation of returns across countries, it is reasonable to expect that international stock returns can be quite different from US stock returns. But it is this low correlation that produces the large diversification benefit of investing internationally. We continue to believe that global diversification (which includes allocations to gold and commodities) has merit. Our research suggests that, for long-term investment, international diversification can have a favorable effect on portfolio risk and returns.