Factors Affecting the Diversification Achieved Through International Investments
The risk of diversification and international investments is the inconsistency of every market; historically, it is rarely possible to predict what market will be a top performer this or next year (Fisher par. 5). Therefore, any downturns in a particular market can negatively influence diversification. Nevertheless, Vermeulen points out that international equity diversification can be beneficial during the financial crisis because “investors hold larger positions in relatively less correlated foreign equity markets during the financial crisis” (20).
Therefore, financial crisis, even though stock market comovements decrease during it, can positively affect diversification, especially for risk-averse and loss-averse investors who are in need to decrease the likely portfolio uncertainty during a financial crisis. As Vermeulen points out, investors from countries with a lower degree of home bias are more likely to enjoy large benefits because they have a better return performance and because the volatility of their portfolio experiences a significant decrease (20). Therefore, removing barriers to foreign equity investments is advisable and should be taken into consideration by policymakers.
Diversification through international investments can also be affected by public and governmental relations activities. In contrast, the decision to become more diversified can be perceived with fear by the public who might view it as an attempt to implement oligopolistic or monopolistic practices (Hitt and Ireland 412). If a firm, a company, or an investor is pursuing diversification via international investments, it should be noted that the mentioned public concerns can also catch the attention of antitrust regulators. Therefore, it is necessary to have a good competency in public and governmental relations activities to calculate their possible effects on diversification and understand what issues can arise during it.
Outcomes of Assets Reacting in Opposite Directions to an Economic Event
The negative correlation between two assets can help the investor evaluate the risks related to these assets, because, using the relations between them, the investor will be able to understand how a specific event influences the assets and what correlation there might be if there are any conditions similar to the event (Haber and Braunstein par. 3). The importance of correlation regarding diversification is that the portfolio cannot be diversified if all of the holdings correlate with each other, i.e. if we can predict how the other holdings will move by looking at one of them and analyzing the changes in the others (Haber and Braunstein par. 8).
Therefore, non-correlation sometimes can present more interest to an investor than any (positive or negative) correlation of the assets. Perse, the negative correlation does help the investor predict how assets will be affected by specific financial (and other) events. At the same time, if the portfolio consists of correlated assets only, it is not diversified, as Haber and Braunstein point out (par. 3). Ferri also notices that correlation is not always significant and that investors often rely on correlation for alpha (par. 12). He points out that believing that rebalancing among asset classes can result in a higher return and a lower risk is not completely wrong but unnecessary because one should not count on it (Ferri par. 14). It can happen but is not guaranteed. Although rebalancing has provided benefit historically, these returns remain hypothetical (Ferri par. 15).
Therefore, an investor should count on real returns and not the possible benefit that is “likely [to get] eaten up by fees, commissions, trading costs” (Ferri par. 18). A negative correlation is not always profitable, and investors should consider that too.