Bridge over ocean
1 January 1996 Financial Analysts Journal Volume 52, Issue 1

Where Are the Gains from International Diversification?

  1. Rex A. Sinquefield

EAFE and international marketlike mandates are popular with U.S. institutional fund sponsors. The rationale seems to be that the international equity market has higher expected returns than the U.S. equity market and can substantially diversify U.S. portfolios. The empirical evidence for the 1970–94 period does not support either claim. Nor does theory help. Asset pricing models do not argue that risk factors have geographically different expected returns. Recent research for the U.S. market shows that two risk factors, value and size, explain differences in expected returns across equity portfolios. Preliminary evidence suggests that the same factors work in foreign markets, as well. International value stocks and international small stocks diversify U.S. portfolios more than EAFE. In fact, a sensible reason to diversify internationally is to “load up” on value stocks and small stocks without concentrating in one geographic region. If one does not wish to concentrate in such stocks, then international diversification for U.S. sponsors may be unnecessary.

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