International Portfolio Diversification
Nevertheless, portfolio investment does not necessarily have to be in foreign financial instruments, it can also be in local financial instruments or in a mix of both local and foreign equities. Evidently, investing in purely local or foreign portfolios has its advantages and disadvantages, but diversification of the portfolio to include both local and foreign equities is said to have more advantages than disadvantages.
Accordingly, this paper will focus on illustrating some of the benefits of international portfolio diversification, in addition to illustrating how three different global funds have been able to use the concept of international portfolio diversification to successfully invest. The Benefits of International Diversification One of the main benefits of international investing is that it offers far more opportunities than investing the in the local market only. More specifically, international portfolio diversification offers the advantage of achieving a better risk-return trade-off than by investing solely in U.
S. or local securities (Shapiro, 2005, p. 411). This means that expanding the universe of assets available for investment should lead to higher returns for the same level of risk or less risk for the same level of expected return (Shapiro, 2005, p. 411). In other words, “The broader the diversification, the more stable the returns and the more diffuse the risks” (Shapiro, 2005, p. 411). The second advantage of international diversification is the fact investment in different international markets can reduce investment risks significantly.
This is due to the fact that the low correlation between the economies of different countries worldwide can offer the investor some safety in the event that domestic or regional economic factors affect all or most of the industries in the market. More specifically, an internationally diversified portfolio is less than half as risky as a fully diversified U. S. portfolio (Shapiro, 2005, p. 414). A third benefit of international diversification the increase in returns resulting from investing in foreign markets that may have higher yields than the local market.
Therefore, it is said that international diversification pushes out the efficient frontier which means that the set of portfolios that has the smallest possible standard deviation for its level of expected return and has the maximum expected return for a given level of risk; thus, allowing investors simultaneously to reduce their risk and increase their expected return (Shapiro, 2005, p. 415). Global Funds Success There are a number of different global funds that have been using the concept of international portfolio diversification to successfully invest for many years.