Some institutional investors may be confined (either by policy or by regulation) to holdings in the bond market. In the 1960–80 period, the U.S. stock market dominated the U.S. bond market in terms of risk-adjusted returns. But an internationally diversified portfolio of bonds dominated an internationally diversified stock portfolio. The low correlations across world bond markets allowed U.S. investors to increase their dollar returns at the price of a smaller increase in risk than that required to achieve the same incremental returns from diversification in stocks.
The gain from international diversification was substantial. A U.S. investor who diversified across world bond markets could have earned more than double the mean rate of return on a U.S. bond portfolio, at the same risk level. For investors not confined to bonds, the gains from international diversification in bonds and stocks were even more impressive.
