Mastering Investment 2001 / Part Ten

An open and shut case for global diversification
By Ian Cooper
Published: July 12 2001 10:39GMT | Last Updated: July 13 2001 14:09GMT

Ian Cooper is a professor of finance, chair of the Finance Faculty, and director of the Institute of Finance and Accounting at London Business School.

The historical average return and risk for various countries' equity markets shows that international diversification results in a much lower level of risk without sacrificing excess return.

This results from the relatively low correlations between the returns on different countries. Yet many investor portfolios remain highly concentrated in their home markets. Attempts to explain this puzzle have failed.

There are perceived problems with international investing including currency risk, that domestic equities are a better hedge against inflation, that the benefits disappear in risky times and that foreign markets are intrinsically risky. However, analysis disproves these arguments.

In spite of this, most portfolios exhibit a home bias. Twenty years ago there were cost barriers to international investing, but most of these costs have been swept aside. It may be, however, that the explanation is institutional.

International capital markets have evolved quickly, but the evolution of governance structures of some investment funds has been relatively slow.