Diversification is no longer what it used to be when it comes to investing in international equities. Global equity correlations have increased significantly following greater trade and market linkages between countries, eroding the traditional diversification benefits of investing in this asset class.
We find that the main benefit of international equity investing is in broadening the opportunity set, and skillful managers with greater flexibility to pursue cross-border investments can generate superior long-term results.
Our research published in The Journal of Portfolio Management yields several ideas for plan sponsors and investors to consider, including:
- Continue to allocate to international equities. International companies make up a significant part of the global opportunity set, and most plans are still underallocated.
- As distinctions across domicile diminish, take a flexible approach to international equity investing. Rather than specifying rigid boundaries between U.S. and international companies, plans should consider including a corridor of permissible allocations in response to changing market opportunities.
- Plan sponsors may seek to adapt allocations across regionally focused funds and can also benefit from delegating more bottom-up flexibility to existing managers. For instance, U.S.-oriented mandates may be permitted greater latitude to partly invest in international equities, and international equity mandates should be allowed to vary the proportion of emerging markets investments.
We believe capital markets and economies have evolved and become more integrated, making the rigidity of distinct equity silos less relevant today. So, it is perhaps time for investment policy to evolve in the area of international equity, this time incorporating more flexibility.