Our third insight is that factor strategies tend to exhibit higher correlations across regions during economic downturns.As is the case within major asset classes, the benefits of diversification weaken when most needed.Accordingly, a voluminous literature focuses on quantifying the degree of markets’ integration and the potential for portfolio diversification.
Diversification is among the most fundamental, well-accepted concepts within our industry: investors can mitigate their portfolio risk by diversifying across different sectors, asset classes, countries, and investment strategies.
The simplicity and robustness of this property makes it an ubiquitous goal across investment funds, asset managers, and advisors.
The returns of neighboring countries are more likely to co-move than geographically distant nations; that is, investors should be brave and look beyond their continents.
We also examine whether geographical diversification exhibits time-varying properties.
In particular, our focus centers on the portfolio implications of international factor investing across a set of major developed markets. First, the potential benefits of global diversification apply to equity factor strategies.
International Portfolio Diversification Research Papers
By diversifying an equity strategy across developed markets, investors can significantly reduce the volatility of their factor portfolio.
Even for a US investor, who has access to a large domestic market, the volatility reduction across the equity factors is estimated up to 30%.
Second, diversification gains do not tend to be equivalent across different regions.
Because of a strong correlation with the first principal component of each equity factor, we conclude that a simple average of the excess returns across the eight regions offers an accurate measure of a global factor.
Except for size, the global factor portfolios are all statistically significant, and the t-statistics of the value, momentum, and profitability factors are above 3.