Is now the time for international diversification?

 

Has international diversification been one of the big loser trades for investors? If you look at returns for US equities and compares to the rest of the world, the answer is yes. You cannot eat diversification, but the returns of the past are not the basis for making future decisions. A recent paper by AQR states the case for international diversification and their arguments are compelling. See "International Diversification - Still Not Crazy After All These Years".

The argument for international diversification is based on five points. One, basic theory has not changed. There is value from diversifying across countries and business cycles. Two, while markets become more correlated when there is a crash, there is still diversification benefit albeit less than expected. Three, changes in valuation can drive returns higher and cause investors to make wrong decisions. The gains in the US equity markets were driven by changes in valuation not the underlying quality of the markets. Four, given the high relative valuation today, there is a bias against the US. Look forward not backward when making the diversification decision. Five, there is a value for active investors across international markets because factor variation is more disperse. 

Again, this may be the time to think about international diversification.