As emerging markets increasingly power global growth, the world is changing dramatically. To capitalize on the opportunities this shift presents, your investment portfolio may have to follow suit. The following synopsis I have provided of the Global Investment Committee's white paper, The Case for Global Diversification, explains why.
In the last 20 years, increased trade between developed and emerging nations has spurred robust economic expansion, helped elevate a burgeoning middle class and fostered enormous wealth creation in emerging markets. On a personal level, globalization has affected everything from where you travel to what your kids wear. But when it comes to your wealth, the global zeitgeist probably hasn't changed the way you invest-yet.
That's not unusual. Indeed, a preference for investments in one's home country is so common it has a name: Home-country bias. It's easy to understand why-stock and bond markets familiar to you seem less risky than ones located off your beaten path. However, home-country bias comes at a cost: You may be missing out on performance and diversification by not incorporating a higher mix of global equities into your investment portfolio in.
While globalization has occurred in varying degrees in modern history, its pace has accelerated in the last 20 years, thanks to factors such as liberalized trade policies, the birth of a global labor force and the fall of the Berlin Wall, which introduced formerly insular economies to market driven models.
The result of a ballooning global labor supply and free movement of trade is that emerging economies are growing much faster than the developed world. During the past two decades, countries such as China, India and Brazil have shown amazing growth as measured by gross domestic product. By 2007, emerging markets as a whole accounted for about two-thirds of the global growth rate.
In tandem with global economic growth, globalization also has significantly changed the composition of global equity market capitalization in the last two decades. That's because as economies develop, local capital markets become more viable and are matched by a growing culture of equity investment from an expanding middle class. As a result, the ratio of equity market capitalization to GDP tends to rise, meaning that emerging markets will likely account for an increasingly large share of global equity market capitalization in the years ahead.
There's a chance some deeply ingrained psychological factors " such as the long-advocated wisdom to buy what you know "are holding you back from investing beyond U.S. borders. But consider the following example of a savvy investor that overcame home bias and seized new higher-growth opportunities across the globe. At one time, the Harvard University endowment fund's only equity exposure was to U.S. stocks, but then it added allocation to developed markets outside the U.S. in 1988 and added emerging markets in 1991. Today, not only is the $35-billion endowment's U.S. allocation far lower than it was 20 years ago, but the portfolio's overall equity position also now includes a sizable allocation to developed non-U.S. equities and emerging equities.
The world has changed and it continues to do so. With the positive effects of globalization poised to play out for years to come, the Global Investment Committee and I believe that you may need to incorporate a higher mix of global equities " one that reflects the global equity market capitalization " into your portfolio if you are going to capitalize on these long-term developments. We believe investors clinging to the familiar and what is perceived as less risky may be doing themselves a disservice.
For more information or a copy of the Global Investment Committee's new comprehensive white paper, The Case for Global Equity Diversification, please contact me at William.a.creekbaum@smithbarney.com or 689-8704.
- William Creekbaum is a senior investment management consultant for Citi Smith Barney. The views expressed herein are those of the author and do not necessarily reflect the views of Smith Barney or its affiliates.