A new study from Research Affiliates suggests that the benefits of global diversification might be enhanced with factor portfolios.
Research Affiliate analysts Jay Binstock, Engin Kose and Michele Mazzoleni looked at whether it pays to use factor portfolios to diversify across developed markets outside the U.S.—Germany, France, the U.K., other European countries, Japan, Asia ex-Japan and Canada.
Six equity factors were analyzed: the market, value, size, momentum, investment (growth in total assets) and profitability. Two periods were studied: 1990 to 2002 and 2003 to 2016.
The key takeaway: Unlike asset classes, correlations of factor portfolios across regions have not been increasing over the last two decades, “making global equity factors a particularly desirable addition to a portfolio,” the researchers say.
Like major asset classes, though, international equity factors’ returns tend to be more correlated during recessions and bear markets, when the benefits of diversification are most needed.
Also, nearby geographic regions, such as the U.S. and Canada, tend to correlate more and so provide fewer diversification benefits. European countries other than the U.K., and Japan, had the highest negative correlations with the U.S. equity market over the study periods.
“Investors should be brave and look beyond their continents,” the paper says.