What Matters in International Equity Diversification?
Posted: 2 Aug 2011
Date Written: July 23, 2011
Over the last decade, there has been renewed interest from investors and financial advisors in increasing international equity exposure. Investors confront one of two key issues in making decisions on their strategic allocations, depending on the starting point of their portfolio: (i) for a US-only equity portfolio, the issue is which strategies produce the most beneficial international exposure; (ii) for a portfolio already with significant international exposure, the issue is what benefits are there in exploring small cap, micro cap and new frontiers in international equity investing. We use mean-variance spanning and optimization tests of indexes to assess the comparative benefits of competing paths to international diversification of the equity segment of an investor’s portfolio. We find that for investors with a US-only stock segment in their portfolio, any of the international indexes examined substantially improve risk and return characteristics; more evidence that home bias is costly. There are no clear winners among the indexes, however. For the investor who already has a diversified portfolio of large and small cap US, large cap developed ex-US, and large cap emerging markets, an extension to small cap emerging markets would be beneficial. The additional diversification and return benefits from extending to small and micro cap non-US developed, micro cap emerging, and frontier markets are small.
Keywords: International Diversification, American Depository Receipts, Small-Cap Stocks, Frontier Markets, Emerging Markets, Mean-Variance Spanning, Downside Risk
JEL Classification: G11, G15, G23, C32, C61
Suggested Citation: Suggested Citation