One of the first rules for successful investment is “diversify your portfolio.” If you want a higher return at lower risk, buy stocks and bonds that don’t rise and fall together. Think builders and debt collectors—builders do well when the economy is growing, debt collectors do better in lean times. An investment portfolio split between construction and debt collection should be considerably more stable than one invested in one or the other.
Globalization gave investors a whole new way to diversify, by putting their money in foreign markets. As barriers to overseas investment fell, savvy investors in the West started putting some of their portfolios in Asian, Latin American, and European exchanges. In theory, this should have reduced risk, since economies don’t all perform the same way at the same time (think China and the U.S. over the past 10 years)—so the stocks and bonds of firms based in different markets shouldn’t, either.
Research by Todd Moss and Ross Thuotte of the Center for Global Development suggests that first movers did gain considerably from that diversity. The monthly correlation between Asian markets and the Standard & Poor’s 500-stock index was roughly zero in 1992; between Latin America and the S&P 500, the correlation was 0.15 (where 1 reflects lock-step movement in price indexes and zero suggests absolutely no relationship between price movements in two different markets). Back in the 1990s, European markets were correlated with the S&P at 0.54. U.S. investors willing to put their money in emerging markets enjoyed a considerably larger diversification advantage by doing so.