Jim Parker, Vice President of DFA Australia Limited observed that, “When you talk about Ireland, cricket is not the first sport that springs to mind. Yet in the 2007 World Cup, the Irish defeated highly rated Pakistan, on St Patrick’s Day no less. Picking the best countries to invest in can be just as unpredictable.”
Parker goes on to say that, on paper, some countries look much stronger than others. In that immortal cricket match, the Pakistan team was full of star professionals. Ireland, by contrast, was a team of no-name amateurs that had never beaten a test-playing nation. Yet Ireland stunned the cricketing world, winning the game by three wickets.
Minnows don’t just win on the sporting field. In three of the past four years, tiny New Zealand has been one of the world’s top performing developed world equity markets, holding first position in 2011, fifth in 2012 and second in 2014.
Denmark, a country not much bigger than New Zealand, has been another top performer, holding second position on the developed world market tables in 2010 and 2012 and third position after the Kiwis last year.
This isn’t to say that those two nations will continue to excel. Look at the example of Spain, which was the worst performing market in 2010 and 2012 as the euro zone crisis dragged on, only to vault into third position globally in 2013.
Country returns are unpredictable and don’t necessarily reflect what’s going on in those markets’ economies at the time. In 2013, amid deflation and continuing sluggish growth, the Japanese equity market put in its best one-year performance in four decades.
In fact, if you assign a colour to each developed market and rank them from the top to bottom performers for each year over the last decade in percentage terms, the resulting haphazard pattern resembles a quilt by a sight-impaired seamstress.
Table 1 shows the percentage performances of all the developed markets over the past decade, ranked from top to bottom.
This lack of a pattern in country returns is actually good news for the diversified investor. It means if you spread your equity allocation internationally, you reduce the risk of any one bad performance having an undue effect on your portfolio.
In other words, the chances are that if one part of your global portfolio is struggling, another will be doing significantly better. That’s the power of diversification.
Obviously, it isn’t as simple as that. There are questions about how much you want to bias your portfolio to your home country.
Another question is around what you do about currencies. Some people choose to leave their international portfolio unhedged against currency moves. In this case, a depreciating home currency can soften the blow of falling international markets and magnify the windfall from rising markets, once you convert to your local currency.
On the other hand, a rising home currency can pare back your international returns if you are unhedged.
It works the opposite way for hedged investors. You are protected when your home currency is rising, but you also don’t get the benefit when it falls.
The research shows no clear investment case one way or the other. So some people choose to have a dollar each way and be 50% hedged and 50% unhedged.
However, once you resolve with your advisor these questions around home bias and currency hedging, there is a strong case for international diversification.
It provides you exposure to a broader array of economic forces, companies and sectors than were you to keep all your money in your home market. It spreads your risk and it means you’re not taking a more concentrated bet than you need to.
Jim Parker concludes, “To use our cricketing analogy, being internationally diversified means you’re more likely to slowly and steadily accumulate runs than trying to hit every ball for six.”
Now, who do you think is going to win the 2015 World Cup? Contact us on 01825 76 33 66 and let us know.
