International diversification: The evidence – Part 1

We owe a lot to the ancient Greeks. They laid the groundwork for a huge swathe of today’s society, including democratic government, philosophy, theatre, architecture, mathematics, jury-based trials, medicine, and the Olympics.

But there’s one aspect of Greek culture which hasn’t managed to endure the test of time – its stock market.

The Greek stock market was hit hard by the 2008 financial crisis, just as many others were. But since the 1st January 2008, the Greek market has fallen an incredible 96%. And that’s on a total return basis.


Greek stock market

Source: Bloomberg

The global stock market (MSCI ACWI), by contrast, is up 152% over the same time period.

So that we can try and avoid the same fate as those who invested too heavily in the Greek stock market, this is the first in a series of posts that examines the evidence behind international diversification.

We saw in the previous post, titled ‘Against international investing’, that cross-country correlations are rising, and that markets all tend to crash at the same time. These are evidence-based arguments against global diversification, and we’ll look at the counter-arguments for them in Part 3 of the series.

But let’s not skip ahead. For now, we’ll start at the beginning.

Why should you own an internationally diversified portfolio?

Nobody knows what’s going to happen


We saw in this post that one of the main reasons we diversify is because we don’t know what’s going to happen. Admitting you can’t see the future is an incredibly powerful way to construct your portfolio – it helps reduce volatility, reduce drawdowns, increase returns, reduce emotional decision-making, reduce stress, and gives you more time to focus on other more important things.  

And this is equally true with international investing. We don’t know which countries are going to do well, and which aren’t.

The Greek stock market is an extreme example, but if we look at data going back to 1900, the US has gone from 15% of the world market to 51%, and the UK has gone from 25% to 6%:

Evolution of equity markets over time

Source: Credit Suisse

While the US might be the largest market in the world now, that hasn’t always been the case. Its route to get there hasn’t been easy either. The US was among the worst-performing stock markets worldwide in the 1970s and the 2000s, and it also earned lower returns than the average international market in the 1980s.

Countries’ returns can wax and wane significantly in the long run, and trying to predict which markets will do well at which point is an almost impossible exercise.

To make country returns more difficult to predict, there’s been significant sector rotation within countries themselves. The pie charts below show the sector composition of both the US and UK markets in 1900 compared to 2019:

Evolution of industry weights

Source: Credit Suisse

The only certain thing in investing is that things change. Rail went from being well over 50% of the US market in 1900 to being dwarfed by the tech giants in 2019. It saw a similar fate in the UK, being eclipsed by energy companies and financials.  

Not only is it almost impossible to predict which economy will be the best performer in the future, but by placing your bets on one country, you run the risk that your country’s economy falls behind the global market. In some cases, economies have not only failed to keep up, but have suffered from multi-decade collapses.

In the fifty years to the end of 2011, the Italian stock market delivered an annual real return of -0.8% per year. That’s a negative real return over 50 years – a truly abysmal return. By contrast, bonds returned 2.64% per year in real terms. In Germany, equities rose 3.46% per year in real terms over the same time frame, again losing to bonds which returned 4.28% a year.

And in Japan, the market still hasn’t recovered to reach its previous high in 1989:

Japanese stock market

Source: Bloomberg

A negative return over 30 years is a terrible result, and that’s even before considering inflation.

By splittin out country returns by decade, you can see that countries performing poorly for extended periods of time happens more often than you’d expect – even among developed markets:

Country returns by decade

Source: Bridgewater Associates

If you start by casting your eye towards the big red boxes for each decade, you can see that a 10-year period of heavily negative performance is a common occurrence for individual countries. What’s interesting is that in 11 of the 12 decades, it was a different country at the bottom of the pack each time (the dubious honour of being the worst performing country of the decade twice is Spain – the 1930s and the 1950s). There are plenty of countries which have experienced decade-long periods of torrid performance, and this should make you cautious if you’re considering making significant bets on any individual countries.

International diversification reduces volatility


One of the advantages of holding an internationally diversified portfolio is that it reduces the chances of holding too much of one of these poorly performing countries. We saw in this post how sector diversification can help reduce risk without sacrificing returns, and exactly the same thing applies with international diversification.

The chart below, courtesy of Vanguard, shows the volatility of individual countries versus the global market. While the United States had the lowest volatility of any individual country examined, its volatility was slightly higher than that of the global market index. Other countries examined had volatilities that were 15% to 100% greater than the global market index.

International diversification reducing volatility

Source: Vanguard

Looking at risk reduction from another angle, international diversification also helps with mitigating drawdowns. The chart below from Bridgewater Associates shows at a glance how powerful international diversification can be in terms of reducing maximum drawdowns in both equity and bonds:

International diversification reducing drawdowns

Source: Bridgewater Associates

Examining the countries’ individual drawdownst in more detail, the table below lists 17 of the largest markets in the world and their worst drawdowns:

Drawdowns by country

Source: Bridgewater Associates

We can see from the table that:

  • The equal weight portfolio’s maximum drawdown is less than almost every country examined.
  • It also recovered quicker than most individual countries, with a number of countries still not reaching their previous highs from over 20 years ago.
  • When the local index suffered its worst drawdown, the equal weight portfolio performed better than the local index (a slightly unfair win for the equal-weight portfolio, given we’re filtering results by each country’s worst drawdown, and not the equal-weight’s worst drawdowns).

A more diversified portfolio helps reduce volatility, reduce drawdowns, and reduce drawdown-recovery time.

While investing only in your home country increases your risk versus an internationally diversified portfolio, for those investors who live and invest in smaller local markets, the risks may be even higher.

As smaller countries are less interconnected with the global economy, they’re likely to suffer more if a ‘Black Swan’ event befalls them. This is according to research from the CFA Institute, who show that the global financial network has developed from a limited number of large centres in the 1990s to numerous smaller centres in the 2010s. In 1989, the United States was the only “super centre,” with 24 connected lines; 2015 saw more centres, including the Netherlands, France, Japan, Germany, and China.

The research finds that a multi-centred structure, rather than a single pivotal centre, may reduce global systemic risk. Although interconnectedness is positively related to systemic risk, a higher GDP, larger population, and stronger currency may help a country to evolve into a systemically important region that is immune to systemic risk. By contrast, smaller local markets have relatively lower GDP, smaller populations, and weaker currencies, which make them more susceptible to systemic risk.

Being a global investor is especially important for those who live in smaller less well-developed economies, as these are the economies most at risk if something goes wrong.

International diversification increases returns


Something noticeable from the brilliant Bridgewater table above (the one showing country returns by decade) is that the equal-weighted portfolio always looks like it’s doing well.

Although it’s never at the top of the table, it’s never the worst performer.

By contrast, you can see the fluctuations for individual countries through time – no one country is consistently outperforming.

In the 2010s, the US was the best performer, but it was one of the weaker performers in the 2000s following the dot-com bust. It was one of the best performers in the 1990s, but before that you have to look back to the 1920s to find a decade in which US equity performance was better than middling. The UK got off to a rocky start, being the worst performer in the 1900s, before becoming the top performer in the 1930s, but has been a consistently average performer since then. Interestingly, it’s underperformed the equally-weighted portfolio in 8 of the last 12 decades.

This consistency of performance for the diversified portfolio leads to incredibly strong returns compared to the individual countries:

International diversification increasing returns 1

International diversification increasing returns 2

Source: Bridgewater Associates

For those that are interested, the 100% loss suffered by the Russian stock market in 1917 was due to Lenin’s Bolshevik revolution, which abolished private property, land, wealth, industry, and closed the country’s stock market.

But the strong and consistent performance of the diversified portfolio isn’t a fluke. There are a couple of reasons why a globally diversified portfolio helps maximise returns:

1) Being diversified reduces the frequency/magnitude/length of large drawdowns. This helps the portfolio minimise the volatility tax, and so helps the portfolio to benefit from compounding over time. The risk-reduction benefit helps the portfolio avoid large losses and gives compounding time to work.

2) Global diversification allows the portfolio to participate in whichever country is driving growth. It’s been shown that since 1990, only 1.3% of stocks created 99% of global wealth – stock returns are highly positively skewed, and the same applies to countries. We saw by looking at the country returns by decade, each country had a period of time where it was the one generating the highest returns. As it’s almost impossible to select which country will be the best performer ahead of time, the diversified portfolio ensures that you’ll always be holding country that’s driving the returns of the global market.



An internationally diversified portfolio provides the following benefits:

  • It spreads your bets. We can’t predict which countries will be the strongest performers in the future, just as we can’t predict which countries will collapse. Diversifying reduces the risk of your home country suffering the same fate of Greece, Japan, Russia, New Zealand, Brazil, Taiwan, or Italy.
  • It reduces volatility. By diversifying, you reduce a portfolio’s volatility, drawdown, time to recover, and vulnerability to Black Swans – especially for those investors in less-developed economies.
  • It increases returns. Diversified portfolios increase returns by minimising the volatility tax, and by owning the few countries which drive the majority of long-term growth.

The next post, imaginatively titled ‘International diversification: The evidence – Part 2’, looks at further benefits of diversifying away from your home country, including: not being exposed to one country’s sectors, one country’s valuations, the irrelevance of a company’s country of listing, and the benefits of including Emerging Markets.

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Past performance does not guarantee future performance and the value of investments can fall as well as rise. The information on this site is provided for information only and does not constitute, and should not be construed as, investment advice or a recommendation to buy, sell, or otherwise transact in any investment including any products or services or an invitation, offer or solicitation to engage in any investment activity. Please refer to the full disclaimer on the disclaimer page.

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January 23, 2021 6:10 pm

Good stuff!

James Baker
February 16, 2020 6:25 pm

Test comment, I would like to be signed up for the newsletter

Dicky P
February 12, 2020 1:05 pm

Never mind the Greeks, what about the Romans??