Cirque du Soleil is diversifying into Russia. Should you?
International diversification has taken a few knocks in recent years – for investors, that is, not acrobats – with stocks looking increasingly interconnected regardless of where they trade.
The 2008 financial crisis is largely to blame. When stocks went downhill in what would become a terrifying bear market, diversification didn't come to the rescue. Everything slid together.
And over the past five years, Canada's benchmark S&P/TSX composite index has outperformed the MSCI World Index and the S&P 500 by a decent margin, giving investors little incentive to look abroad for a better portfolio. After all, diversifying to underperform doesn't sound like a great selling feature.
However, while Russia's stock market might not be to everyone's taste, there are still compelling reasons to send some of your money overseas – whether that's through individual stocks, country indexes or even regional indexes.
Global stocks might be moving in the same direction on most days (especially during downturns), displaying what some observers would call a high level of correlation. But that doesn't mean overall returns are the same.
Just take a look at the performances of major indexes in 2012. Canada is a laggard, with a gain of just 4 per cent so far. Meanwhile, U.S. stocks are up 11 per cent, German stocks are up 19 per cent and Turkish stocks are up 20 per cent.
This isn't unusual. While global economic growth is still a big driver of returns, domestic factors such as tax laws, monetary policy and fiscal health also play a big role in how a country's stock market performs. In emerging markets, these domestic factors can differ far more than in developed markets, boosting their importance to returns.
Of course, it's impossible to know which country will be tomorrow's winner, but that's where the benefits of diversification kick in: This year's loser could easily be next year's hero, and vice versa. When you spread out your bets, the overall volatility of your portfolio will likely decline.
The problem is that many investors don't diversify properly. When they do diversify abroad, they tend to stick with familiar territory (Guess what? The U.S., Canadian and Australian markets aren't all that different), which might not bring any benefits.
Say what you want about Russia, but it's not familiar territory for Canadian investors. And maybe that's not such a bad thing.
David Berman