When global market bets went wrong

The author is a financial journalist and author of ‘More: The Rise of the 10,000 Years of the Global Economy’

It has been described as the easiest free lunch in investment: diversify your investment portfolio and achieve a better compromise between risk and reward. This still seems true when it comes to the number of stocks investors have in their domestic market.

But a new study by Elroy Dimson, Paul Marsh and Mike Stonton from the London Business School shows that this is not always the case with international diversity.

In writing the yearbook of Credit Suisse Global Investment Returns, the academy examines the history of international diversity since 1974, when Bruno Solnik wrote Paper affects On the subject in the Journal of Financial Analysts. In particular, they focus on the experience of American investors.

Many U.S. institutions have significantly increased their overseas asset allocations in recent decades; the proportion of non-domestic equities held by U.S. pension funds rose from 1% in 1980 to 18% in 2019.

This diversity has not paid off in terms of overall return; US stocks outperformed non-US stocks by 1.9% a year between 1974 and the end of 2021. High performance was even greater after 1990, at 4.6% a year.

Nor did diversity help in terms of reducing volatility; On average, non-U.S. markets were about twice as volatile as the U.S. market. So the Sharp ratio, which measures the relationship between yield and volatility, was significantly better for U.S. investors who stuck to the domestic market than for those who dared themselves overseas.

America’s strong performance means that international diversity has paid off better for investors elsewhere. Of the 32 countries where academics have detailed returns between 1974 and 2021, international diversity has paid off (in risk-adjusted terms) in 24 of them. This figure would have risen to 28 if investors had hedged their exposure to the currency.

But the big question is whether the future will be similar to the past. The U.S. stock market was down in 1974, but despite some occasional shocks in the last 50 years, it has performed remarkably well. It now accounts for 60 percent of the global market (as measured by academics) and is even more dominant than the 54 percent it held in 1974. This is much more than America’s share of the world economy, which is around 24 percent, down from 36 percent in 1970.

However, the connection between a country’s economy and its stock market is much less clear than it once was. Many of America’s largest companies, such as Alphabet, Apple, and Microsoft, are global brands that derive much of their revenue and profits from outside the U.S. In a sense, the corporate sector has diversified on behalf of investors. US Monetary.

Another factor that may deter American investors from diversifying is that global stock markets are much more coordinated than they were before the collapse of Burton Woods’ fixed exchange rate system in the early 1970s. Between 1946 and 1971, LBS academics found that the average correlation between the markets in the US, UK, France and Germany was 0.11 – a modest positive ratio. Between 2001 and 2021, this correlation rose to 0.88, meaning that markets moved in the same direction almost all the time. .

Still, the geographical risk did not completely disappear as the collapse of the Russian market showed after the invasion of Ukraine. This is not the first time that investors in Russia have seen their portfolios Russian. Russia was the fifth largest global stock market, by value, in 1900, but all value was erased after the 1917 revolution.

In 1998, when the Russian government lost its debt, stock investors lost 75% in real terms. Germany was the third largest stock market, by value, in 1900, but investors then suffered three periods of huge real losses, during the two world wars and the hyper-inflationary period of 1922-23.

While it seems like nothing so serious will happen in the U.S., a gamble on its domestic stock market still implicitly assumes that the country’s strong position will continue. More regulation in the future.

This could hurt their future earnings growth or, at the very least, their valuations. The wave of international sanctions on Russia, and trade tensions between the US and China, suggest that globalization may be in retreat, and globalization has generally been very good news for the US corporate sector.

It is a reasonable bet that American investors will benefit more from international diversity in the next five decades than in the last five. Given the greater correlation between global markets, international diversity may no longer constitute a free lunch but it still seems like a sensible piece of insurance.

When global market bets went wrong Source link When global market bets went wrong

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