Seeking Alpha

Is Global Diversification Dead?

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Includes: EEM, EWA, EWG, EWI, EWN, EWQ, EWU, IVV, SPY, XLF, XLP, XLU, XLV
by: David Hunkar

I do not believe that the global diversification strategy is dead for some of the reasons discussed at the end of this article. However this year it hasn’t helped investors. Many foreign markets have fallen more than US markets.

In the US, the S&P 500 Index is down 40.53% year-to-date (YTD) as of November 14, 2008. Within the index, the financials are the worst performers, down 56.76% YTD. Consumer Staples components are down only 19.24% YTD. Healthcare, the second best performing group is down 27.29%. The interesting fact about this bear market is that even the utilities sector is down 32.6%.

SP500 Index Returns

Name Year-To-Date Change (%)
S&P 500 Index -40.53%
   
Financials -56.76%
Utilities -32.96%
Health Care -27.29%
Consumer Staples -19.24%

Source: Standard & Poors

To analyze how foreign markets have performed this year, I used the Bank of New York Mellon ADR Indices. These indices are cap-weighted. Though the bank publishes a composite ADR Index and three regional indices, I used the individual country indices for this study.

Bank of New York Mellon ADR Indices

ADR Index Year-To-Date Change (%)
Argentina -60.85%
Australia -54.65%
Belgium -31.75%
Brazil -58.42%
Chile -17.15%
China -56.71%
Colombia -45.06%
Denmark -23.69%
Finland -67.20%
France -46.37%
Germany -60.01%
Greece -68.41%
Hungary -51.17%
India -60.99%
Indonesia -53.14%
Ireland -65.98%
Israel -10.02%
Italy -43.17%
Japan -40.32%
Korea -63.20%
Mexico -51.13%
The Netherlands -59.18%
New Zealand -59.24%
Norway -49.65%
Peru -53.96%
Philippines -39.02%
Portugal -41.55%
Russia -74.38%
Singapore -79.28%
South Africa -53.14%
Spain -51.90%
Sweden -44.15%
Switzerland -43.98%
Taiwan -37.99%
Turkey -56.65%
UK -48.60%

 Source: Bank of New York Mellon

Analysis

Compared to the S&P 500's Index performance of about -41%, the markets of the developed world have been worse. The ADR Indices of France (NYSEARCA:EWQ), Australia (NYSEARCA:EWA), Germany (NYSEARCA:EWG), UK (NYSEARCA:EWU), The Netherlands (NYSEARCA:EWN), Italy (NYSEARCA:EWI), etc. are down more than the S&P 500 Index.

Since the ADR Indices include only the Depository Receipts listed in the US, it is possible that the main market index of the respective countries might have fared a little better or worse. To solve this issue, I reviewed the performance of the base index used for the country-specific ETFs issued by iShares. Even with this logic, the above six developed countries are down more than the S&P 500.

As for the emerging countries, no research is needed as their markets have fallen heavily in recent months.The ADR indices of the BRIC countries are worse off than the S&P Index by more than 10%. Russia is the worst performer in this group due to the crash in crude oil and other commodity prices.

The Chile ADR Index is down only about 17% YTD. This is interesting since Chile is also an emerging market with heavy dependence on commodities exports, especially copper.

Some of the reasons why global diversification is an integral part of any investment strategy:

1. Foreign stocks have higher yields than US stocks. For example, New Zealand stocks yield on an average 4X the yield of US stocks. Similarly, other countries such as Sweden, UK, Peru, Australia, etc. have higher yields. (Source: Bloomberg)

2. The declining dollar will be favorable to investors investing in overseas markets.

3. By investing only in US stocks, an investor will miss out on many high quality overseas stocks that offer great yields and stable long-term growth.

4. Over the last 25 years, the US market was not the best performer even once among the developed markets in the world as per The Callan Periodic Table of Investment Returns:

The Callan Periodic Table of Investment Returns

click to enlarge

Callan Charts

Source: Callan Associates

It must be noted that foreign exchange, transaction costs, taxes etc. have not been included in the above analysis. When those are taken into consideration it is possible that the returns of foreign markets may be lower for US investors.