International Diversification
Introduction Diversification is a method of investing that been shown to increase portfolio return while reducing portfolio risk as measured by standard deviation. This method specifically increases the efficient frontier for investors. The challenge to an investing firm is an appetite by its customers for an ever increasing efficient frontier. One area to explore to obtain this increase is through further diversifying through international diversification. International portfolio diversification gives your investments a passport to added diversification benefits. The international boundaries to investing have collapsed. Fairly recently, foreign securities have become easier to trade due to improved communications and data technology. Worldwide investors have been realizing that there are substantial gains to be made by investing internationally. International portfolio diversification is portfolio investing in other nations whose economic cycles are not perfectly in phase, in an attempt to reduce risk, measured by portfolio standard deviation. The success of international portfolio diversification depends on low correlations of returns between countries. Investing in a country with an economic cycle that closely matches or exactly matches the economic cycle in the investor’s home country will offer little or no diversification benefits. What is meant by a diversification benefit is a reduction of portfolio risk when an asset is added to a portfolio. The same principles that go along with domestic portfolio diversification can be applied worldwide. Opening the gates of an investor’s portfolio to the world offers the investor several advantages. The benefits include: a world focus; broad diversification; and low correlations. These advantages will lead the investor to have greater success in achieving his financial goals. By investing internationally, an investor will realize that he now has a world focus. More than half of the world’s stock market