We’ve observed that many institutional investors have abandoned their historical domestic-equity bias and now view global equities as a single, broad asset class. In high-growth economies, however, particularly in Asia, Central and Eastern Europe, Africa and Latin America, many investors remain focused primarily on domestic stocks. A study by MSCI shows that during, the period between January 1, 1990 to December 31, 2010, adopting a global investment framework assisted institutional investors from high-growth countries to:
- Access a broader range of global investment opportunities.
- Avoid the risk that high-growth in local economies fails to translate into above-average investment returns.
- Reduce portfolio risk and improve return-to-risk profiles, based on results over the last two decades.
Historically, equity markets of high-growth economies have attracted investors on the assumption that strong economic growth will persist and produce superior equity returns.
However, economic growth can decline over time. In addition, many local companies now derive significant revenue from foreign sources, because of increased globalization. In such cases, domestic equities may not be capable of fully capturing the benefits of local economic growth.
In recent years, regulatory hurdles to international investing in many of these high-growth economies have been lowered. Many investors in these countries may now have higher levels of wealth and find the capacity of local equity markets limiting. They may also be concerned about the risks of excessive home-country concentration.
MSCI’s study looked at the historical performance of 23 high-growth economies in two 10-year periods: the 1990s and the first decade of the new century. In the 1990s, local stocks in 20 of the 23 high-growth countries underperformed a diversified global portfolio. In the following decade, 13 failed to match global returns.
A well-diversified global equity portfolio had another important advantage, the MSCI study showed. It benefited from portfolio diversification, particularly during a domestic market crisis. Looking at the same 23 markets for the 20-year period ended in 2010, MSCI found that adding varying amounts of global equities to a mix of local stocks lowered portfolio risk by an average of 18% to 39%. Return-to-risk profiles improved by 13% to 28% on average.
In the event of a local market crisis, institutional equity investors with diversified global stock exposure could manage their liquidity needs by rebalancing their international equity exposures, while leaving their domestic portfolio untouched.
Effect of a forced rebalancing during crisis
In short, unless investors have a strong conviction on the future performance of domestic equities versus global equities, home-biased equity allocations can bring significant active risk to investors’ portfolios. A global equity framework has the potential to reduce risk and improve a portfolio’s return-to-risk profile.
To read the paper, “The Next Generation of Global Investors,” click here.