How Diversifying Can Help You Manage Market Mayhem
Geography
It’s natural to have a home-country bias, and the US is still one of the strongest markets in the world. But there’s no denying we live in a global economy. There can be real benefits to expanding your geographic horizon to pursue opportunities in other regions and countries. Try to have a risk-balanced blend of investments across developed and emerging markets so you’re well positioned globally. Also, keep in mind that the value of the dollar against other currencies has become more important to your bottom line lately. So consider whether some currency-hedged exchange-traded funds (or ETFs) may help to protect your portfolio against sudden changes.
Market Realist – You should pursue opportunities in other regions to improve your risk-return profile.
Diversifying your equity portfolio across various geographies and segments is important to improve your risk-return profile. Segments like emerging markets and frontier markets help you get access to higher growth, even though you take on higher risk.
The graph above shows the correlations of emerging markets (EEM), frontier markets (FM), the S&P 500 (SPY)(RSP), and developed markets outside North America (EFA) with one another considering weekly returns over the last five years.
The correlation between the S&P 500 and other developed markets is high at +0.86. The correlation between the former and emerging markets is lower at +0.75. The correlation between the S&P 500 and the frontier markets is even lower at +0.41. The correlation between emerging markets and frontier markets is relatively low at +0.54.
Since global markets are becoming more intertwined, correlations between various geographies are rising. However, they’re still low enough to give diversification benefits. If you only hold US stocks, it denies you of opportunities abroad.
Browse this series on Market Realist: