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One of the drawbacks
of investing offshore is that the benefits
of international diversification vary considerably
over time and between markets. In bear markets,
for example, the correlations between international
equity returns tend to increase, particularly
among the major industrial markets. This
is not good news for investors because it
makes avoiding share market slumps very
difficult. If you invest outside your own
market, you just end up losing money in
more places!
So is moving out of equities altogether the only solution in bear
markets? Maybe not, according to a recent US study
by Conover, Jensen and Johnson (2002). The authors examined the
performance of US, major market and emerging market equities during
the period 1976-1999, with a particular focus on the impact of US
monetary policy settings. One of their key findings was that investment
returns in emerging markets appear to be less responsive to US interest
rates than those in major industrial markets.
In fact, an environment of rising US interest rates, which is usually
negative for major share markets, was invariably the best
time to invest in emerging markets. During their sample period,
the inclusion of emerging market equities improved portfolio returns
by about 1.5% p.a. but virtually none of the gains occurred when
US rates were falling. In contrast, for periods of restrictive US
monetary policy, the addition of emerging market shares boosted
total returns by around 4.5% a year.
 So far this year, emerging market equities
have risen by 4.9% in US$ terms compared to an 8.9% fall in the
MSCI World Index. This outperformance has surprised many analysts
who thought that terrorism fears and rising US interest rates would
stymie volatile financial assets like emerging equities. But if
US interest rates are heading higher, there could be further gains
to come.
Reference:
Conover, C.M., Jensen G.R.,
Johnson R.R., "Emerging Markets: When Are
They Worth It?" Financial Analysts Journal,
Vol.58, No.2, March/April 2002.
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