Building portfolios that are as resilient as possible to the variety of ways the world could unfold is the best approach we know to produce consistent returns and preserve wealth. Geographic concentration is a typical weakness. Geopolitical upheavals, debt crises, monetary reforms, and the bursting of bubbles swept off the wealth of investors concentrated in one country, while markets in other countries remained resilient. The outperformance can lead to relative overvaluation and a later reversal, therefore no single country regularly excels. As a result, a geographically diversified portfolio produces a more constant return stream that performs almost as well as whatever the best single country is at any given time.
Because of globalization and the free flow of wealth, countries' economies and markets have grown increasingly linked. The recent tendency of de-globalization, which has been exacerbated by trade wars, the Covid19 epidemic, and religious conflict, has increased the likelihood of diverging results inside and across countries.
To demonstrate the importance of geographic diversification, we compare the features of return streams from particular nations to a portfolio that is equally weighted across countries and rebalanced annually.
Geographically diversified portfolios outperform because they reduce drawdowns, resulting in a more steady return stream and faster compounding. Even when we construct portfolios that are diversified across economic circumstances, regional diversification adds substantial value.
As markets move toward equilibrium pricing, the best and worst performers naturally fluctuate over time.
The outperformance can lead to relative overvaluation and a later reversal, therefore no single country regularly excels. So far, the United States has been the best performer, but it was one of the worst performers in the previous decade following the dot-com bust; it was one of the best performers in the 1990s, but before that, you have to go back to the 1920s to find a decade in which US equity performance was better than mediocre.
There have been numerous instances where a country's equity market has been wrecked, and recovering from the losses might take decades. Despite the fact that many of them have track histories that are decades shorter than the equally weighted portfolio, most countries have seen worse drawdowns in the past.
The equally-weighted stock portfolio suffered significant losses at times, but had shorter and shallower drawdowns, and it recovered faster than most individual nation equities markets..
Geographic Diversification Is Likely to Be More Important in the Coming Decades
The postwar era's boom of globalisation under US supremacy, with expanding trade and capital linkages across countries, has resulted in unprecedented high correlations between country equity returns. Rising commerce and globalization-related conflict may exacerbate regional disparities in the future. The rise of China as a major economic and financial centre with secular characteristics that differ from those of most of the developed world (e.g., greater ability to boost in the case of a downturn) increases the chance of a more multipolar and less correlated world. All of these factors highlight the need of diversification in the future.
Investors in the developed world are similarly under-allocated compared to the rest of the emerging world, and they have a strong home country bias, leaving them geographically concentrated.
To add more value to their portfolio and construct a resilient portfolio to protect their cash, investors should consider adding regional exposure.
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