Does it pay to diversify?

Abstract

Individual investors seek diversification in their portfolios using a number of approaches. One approach that is commonly used is to diversify globally. This article evaluates the performance and diversification benefits of international ETFs for U.S. investors during and after the recent financial crisis. Our results show that U.S. ETFs outperform all categories of international ETFs for the period of our study (January 2008 – June 2013); they have higher average monthly returns, lower risk (standard deviation of returns), higher risk-adjusted performance (Sharpe, Sortino, and Treynor ratios) and the highest cumulative returns over the entire period. When we form equally weighted portfolios of each ETF category and compute their risk-adjusted performance, we again find that U.S. ETF portfolios had the best performance for the entire period. We also find that U.S. ETFs have the lowest tracking error during the entire period. Most of these ETFs passively track the benchmark and do not manage for positive ɑ. Previous research has questioned the diversification benefits of international investing during times of financial distress. We find that international ETFs are highly dependent on major U.S. indices during the period of our analysis, and therefore, offered limited diversification benefits for U.S. investors.