International Diversification

International diversification is the act of investing in a broad range of companies’ stocks from around the world, to help you capture market returns while spreading your risks around. It’s a simple enough concept. But, oh, the debates that rage over the details!

1. Have our global economies become so uniform that it’s impossible to separate one from the other, rendering diversification a moot point?
2. Can we expect stocks in general to continue delivering higher returns than their fixed income counterparts?

Looking past the daily stream of noisy news, it seems to me there’s ample evidence that international diversification is here to stay, and that global stock investing can be expected to deliver solid returns over time … for those who stay the course with a well-diversified portfolio.

Diversification Still Matters

First, let’s address whether our world has grown too homogenous to offer a diversification benefit. A glimpse at recent returns indicates otherwise. As reported by Jared Kizer of Multifactor World: “Over the period December 31, 2010 to May 21, 2012, the S&P 500 Index was up 7.8 percent, while the MSCI EAFE Index (basically the international equivalent of the S&P 500) was down 12.9 percent.”

Of course the reverse scenario also has held true, when U.S. stocks have lagged international … or run parallel. That’s why I don’t endorse attempts to predict and invest according to these ebbs and flows. Spread your holdings across the gamut and hang on tight, because the point is, international diversification seems alive and well.

Additional evidence is found in a 2010 paper, “International Diversification Works (in the Long Run).” The paper assessed data across 22 countries across more than a half-century (1950–2008). The conclusion: “International diversification might not protect you from terrible days, months, or even years, but over longer horizons (which should be more important to investors) where underlying economic growth matters more to returns than short-lived panics or global coordinated events, it protects you quite well.”

Equity Investing Still Matters, Too

But even in a globally diversified portfolio, will stocks in general continue to deliver premium returns? One reason I believe we can continue to expect this to be the case is illustrated in a recent article by Jim Parker of Dimensional Fund Advisors, in which he asks what the following companies have in common: Whitbread of the United Kingdom, Molson Coors of North America, Qantas of Australia, Honda of Japan, and Adidas of Germany.

The article describes how each and all of these companies are well-established, internationally recognized consumer product providers that, today, employ thousands and sell their wares worldwide. And they all happen to share long histories with humble beginnings. Another common theme: They’re part of our global market. That is, you can purchase stock in them if you want to share in their future.

As Parker says, “They have grown from humble beginnings, partly because they have issued equity and tapped the savings of millions of investors, who in turn have shared in their successes. This seems an important point to remember in the face of bad news, whether home or abroad … Sharing the wealth means owning shares.”

As Parker further notes, “For all its troubles, the world economy is still growing. The International Monetary Fund estimates global economic growth this year of about 3.5%, accelerating to 4% in 2013. For emerging and developing economies, the growth assumptions are about twice that.”

Perhaps Parker’s — and my own — optimism is founded in an observation made by Nineteenth Century journalist Anatole France, which seems to still hold just as true today: “Man is so made that he can only find relaxation from one kind of labor by taking up another.”

I may not be able to predict what that labor will be, where it will happen next or what, exactly, it will produce. But I feel pretty good that those labors will continue all around the world. By investing in stocks accordingly (including wide diversification to minimize single-stock risks), you can expect to share in the results — wherever, whenever and however they occur.