International Equities and Diversification

The evolution of the global economy has changed the relationship between U.S. and international stocks such that equity investments in many developed companies provide little diversification benefit. This according to an article in CFA Institute.

The article argues that although many U.S. investors allocate to international equities in the hopes of diversifying portfolio risk without compromising long-term returns, the data paints a different picture. Specifically, it reports, “sometime in the mid-1990s, international stocks stopped outperforming U.S. equities and have underperformed ever since.”

The following chart presents what the article describes as a “troubling picture”—to maximize an equity portfolio’s risk-adjusted returns, the percentage allocated to US stocks has slowly drifted toward 100%. This means that not only have international stocks lagged their U.S. counterparts over the last several decades, but their diversification benefits have also deteriorated:”

The article notes that the exact reason for the shift is difficult to identify, “but globalization and the internet revolution have likely played a role. And neither of these developments is likely to be dialed back.”

The article concludes that, since long-term investments in international indices adds less value to a portfolio than they did in the past, investors should “re-evaluate the assumptions they have made based on the long-term relationship of U.S. and global stocks and consider adjusting their allocations accordingly.”