Fundamentally....Wrong

Sometimes the poor logic in investing columns is so blatant it is startling. Such was the case in the NYT's "fundamentally" column on investing

my comments in blue

Don’t Let the Euro Dictate Your Portfolio

By PAUL J. LIM

FOR Americans with significant exposure to foreign stocks, the euro’s 16 percent decline against the dollar this year may lead to second thoughts.

... the currency’s fall to $1.21 last week from $1.43 at the start of the year has only exacerbated those losses....

But before investors start changing their portfolios because of concerns over currency risk, market strategists advise them to consider several things...

Perhaps the best case for maintaining overseas holdings, though, is that exposure to different currencies has been shown to make a portfolio more stable, and not more volatile, in the long run.

How is that possible?

Stock markets around the world have grown more correlated, thanks to the effects of globalization. In fact, there is now a correlation level of about 0.9 between movements in the Standard & Poor’s 500 index of domestic stocks and the EAFE. (A correlation of 1.0 would indicate that two investments were in perfect sync.)

So the only possible conclusion from the above is that adding European stocks to a US stock portfolio  adds virtually no diversification to a portfolio.

The only real correlation comes from holding the foreign currencies outright not by holding the European stocks:

But Peng Chen, president of Ibbotson Associates, the investment advisory firm, notes that currency fluctuations are one aspect of foreign investing that has been shown to be essentially unrelated to movements in the S.&P. 500. In fact, over the last 20 years, the correlation between movements in European currencies and the S.& P. 500 has been just a negative 0.07, he said.

 Owning  european stocks is bad way  to get diversification.  Even though Mr. Lim tells his readers to hold onto stocks to get diversification.


The way to get diversification is to own foreign currencies. Lim presents the data but makes the wrong recommendation (holding onto the stocks)

better to follow this advice not advocated by the author but included in the article: 

MICHELE GAMBERA, head of quantitative analysis at UBS Global Asset Management in Chicago, says that even if foreign stocks no longer zig when domestic shares zag, one reason that these asset classes don’t always post similar returns each year is the currency effect.

“By having even some passive exposure to different currencies, you are adding diversification,” he said.

Interestingly the WSJ has a nice review of various ways to get currency exposure without entering the dangerously leveraged futures and cash currency markets