Some interesting charts and tables in the nyt over the weekend (see above) sent me to the computer to put together some numbers for 10 year data. The top chart (click to enlarge) shows the 10 yr growth of a $1 investment domestically and internationally. In descending order ten year performance : emerging markets 11.49%, total world ex us 3.94%, developed international 2.46% and S+P 500 - .95%.
While many after last year's turmoil have argued that "diversification doesn't work" my response would by: yes and no. Diversifying across types of equities is not likely to insulate a portfolio from market declines. Among the non US categories listed above all the correlations to the US mkt were all virtually the same= around .8. So it is certainly unlikely that one's foreign stocks will "zig" while the domestic stocks "zag". In fact as we have seen in several market crises "the only thing that goes up in a down market is correlation". The correlation between all types of risk assets goes up in a sharp market decline. The only asset that diversifies away from market risk are riskless assets such as tbills.
But this does not argue against global diversification within one's equity allocation. As can be seen from the data here much of the growth in the world can come from outside the US and while it is true that stocks are highly correlated around the world it does not argue for missing out on global growth. In fact whether on a global gdp basis or a global market capitalization perspective one could argue that investors' portfolios should have a significant allocation to non US stocks.
In my view that international allocation should contain at least an equal weighting of developed and emerging market stocks based on the relative outlook for growth around the world. Of course this is not for the faint of heart, emerging markets in the past and likely in the future have more volatility than US stocks. Besides the relative growth story. One can argue that in increasing one's weighting in emerging markets one also has the strength of future money flows as a tailwind:
Institutional investors around the world are strategically increasing their international and emerging weightings. US institutions are significantly underweighted (one report shows them less than 12% weighted in non us stocks).
Despite the large "hot money" flows into emerging markets of late, US retail investors retain a heavy "home country bias" something that will be changing among more stable 401k and other retail investors.
Probably even more importantly as the middle class grows in these markets locals will begin to have investable savings which they will invest in their home markets. Add in an infrastructure of pension funds, insurance companies and mutual funds all of which are at their infancy and one can imagine quite a bit of room for more money to flow into the equity markets of the emerging markets.
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