International Diversification Works (Eventually)

Abstract

Investors and financial economists have long debated the benefits of global equity market diversification. Fans argue that diversifying globally reduces portfolio risk without harming long-term return. Some critics counter with the observation that because markets get more correlated during downturns, most of the diversification occurs on the upside when you do not need it, and vanishes on the downside when you do. Certainly, recent events give support to the critics as all equity markets suffered at the same time. We argue that this observation, while true, misses the big picture. International diversification might not protect you from terrible days, months, or even years, but over longer horizons (which should be more important to investors) where underlying economic growth matters more to returns than short-lived panics, it protects you quite well.

Keywords: Diversification, International Diversification, Global Diversification, Home Bias

JEL Classification: G11,G15