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Geographic Diversification Can Be a Lifesaver, Yet Most Portfolios Are Highly Geographically Concentrated

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Geographic Diversification Can Be a Lifesaver, Yet Most Portfolios Are Highly Geographically Concentrated Geographic Diversification Can Be a Lifesaver, Yet Most Portfolios Are Highly Geographically Concentrated FEBRUARY 2019 MELISSA SAPHIER KAREN KARNIOL-TAMBOUR PAT MARGOLIS © 2019 Bridgewater Associates, LP he best way we know to earn consistent returns and preserve wealth is to build portfolios that are as resilient as possible to the range of ways the Tworld could unfold. To uncover vulnerabilities that are outside of investors’ recent lived experiences, we find it valuable to stress test portfolios across the various environments that have cropped up across countries throughout history. One common vulnerability is geographic concentration. dominant economic force and keeper of a stable global In the past century, there have been many times when geopolitical order. Looking ahead, China’s ascent as an investors concentrated in one country saw their wealth independent economic and financial center of gravity wiped out by geopolitical upheavals, debt crises, monetary with an independent monetary policy and credit system reforms, or the bursting of bubbles, while markets in is highly diversifying, making the world less unipolar other countries remained resilient. Even without such and less correlated. At the same time, the rising risk of extreme events, there is always a big divergence across conflict within and across countries also increases the the best and worst performing countries in any given chances of divergent outcomes. Additionally, geographic period. And no one country consistently outperforms, as diversification felt less urgent during the recent decade outperformance can lead to relative overvaluation and a of great returns for most assets and portfolios. Low asset subsequent reversal. Rather than try to predict who the yields going forward make diversification and efficient winner will be in any particular period, a geographically risk-taking all the more important to investors. diversified portfolio creates a more consistent return stream that tends to do almost as well as whatever the To illustrate the impact of geographic diversification, we best single country turns out to be at any point in time. begin by looking at the characteristics of return streams So geographic diversification has big upside and little from single countries relative to weighting a portfolio downside for investors. equally across countries, rebalancing annually. The chart below shows cumulative returns above cash back Geographic diversification is likely to be more important to 1900 for the equity markets where we have reliable in the coming decades than it has been in our lived data going back over 100 years. An investor concentrated experience as investors. Through most of our working in Russia or Germany in the early 20th century would lifetimes, countries’ economies and markets have become have lost most or all of their wealth, while an equally increasingly intertwined due to globalization and the weighted mix of the five countries shown below does free flow of capital, under the auspices of the US as a almost as well as the best performer. Equity Market Cumulative Excess Returns Since 1900 (ln Scale) DEU GBR USA FRA RUS Equal-Weight 300,000% 40,000% 5,000% 600% 0% -80% -98% -100% 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 © 2019 Bridgewater Associates, LP 1 Looking at a broader set of stock and bond markets back to 1950, you can see that an equally weighted mix has consistently performed well. And while no single equity market has suffered as much as Germany and Russia did in the first half of the 20th century, there is still a broad range of performance across countries, with the US fluctuating like any other country. In the charts below, the gray lines represent individual countries, with the US called out in dark gray, while the equally weighted mix is shown in red. Cumulative Excess Returns (In) Individual Countries USA Equal-Weight Stocks Bonds 6 2.5 5 2.0 4 1.5 3 1.0 2 0.5 1 0.0 0 -0.5 -1 -1.0 1950 1970 1990 2010 1950 1970 1990 2010 The geographically diversified portfolios do so well because they minimize drawdowns, creating a much more consistent return stream that allows for faster compounding. Drawdowns (Excess Returns) Individual Countries USA Equal-Weight Stocks Bonds 0% 0% -10% -10% -20% -20% -30% -30% -40% -40% -50% -50% -60% -60% -70% -70% -80% -80% -90% -90% -100% -100% 1950 1970 1990 2010 1950 1970 1990 2010 © 2019 Bridgewater Associates, LP 2 This basic picture holds through time regardless of the starting point, as shown in the following charts of the 10-year rolling return-to-risk ratio across individual countries and a diversified portfolio. Rolling 10-Year Return-to-Risk Ratio Individual Countries USA Equal-Weight Stocks Bonds 3.0 1.5 1.0 1.5 0.5 0.0 0.0 -0.5 -1.0 -1.5 -1.5 1950 1970 1990 2010 1960 1980 2000 2020 Even when we create portfolios that are diversified across economic environments (what we refer to as an All Weather mix of assets, balanced to perform equally well when growth or inflation are rising or falling), there is significant value to adding geographic diversification (as we do in our own All Weather portfolios). The charts below repeat the first two perspectives we showed above, this time for country-specific All Weather mixes as well as our own geographically diversified All Weather asset mix. Country-Level and Global All Weather Asset Mixes (Simulated, Gross Excess Returns) Individual Countries USA Global All Weather Asset Mix Cumulative Returns (In) Drawdowns 5 0% -10% 4 -20% -30% 3 -40% 2 -50% -60% 1 -70% -80% 0 -90% -1 -100% 1950 1970 1990 2010 1950 1970 1990 2010 1 1 Where shown the Global All Weather Asset Mix and Country-Level All Weather Asset Mixes are simulated. It is expected that the simulated performance will periodically change as a function of both refinements to our simulation methodology and the underlying market data. HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS. Past performnce is not indicative of future results. Please review the disclosures located at the end of the Daily Observations. © 2019 Bridgewater Associates, LP 3 The Best and Worst Performers Naturally Fluctuate Through Time as Markets Move Toward Equilibrium Pricing To get a better feel for what an investor would have a subsequent reversal. This decade, the US has been experienced in any given period and how it compares to the best performer so far, but it was one of the weaker the longer-term range of outcomes, the table below looks performers in the previous decade following the dot- decade by decade at how equity performance across com bust; it was one of the best performers in the 1990s, countries stacks up. You can see the fluctuations through but before that you have to look back to the 1920s to find time; no one country is consistently outperforming, as a decade in which US equity performance was better outperformance can lead to relative overvaluation and than middling. Rankings of Equity Excess Returns by Decade 1900s 1910s 1920s 1930s United States 83% United States 10% Equal Weight 249% United Kingdom 6% Equal Weight 9% France -35% Germany 178% Germany 2% France 9% United Kingdom -44% United States 170% Canada -9% Germany 9% Equal Weight -54% Canada 134% Equal Weight -10% Russia -7% Germany -92% United Kingdom 87% United States -12% United Kingdom -34% Russia -100% Spain 72% Sweden -22% France 41% France -54% Sweden 24% Spain -61% 739% 739% 739% 739% Avg. Correl. 19% Avg. Correl. 3% Avg. Correl. 26% Avg. Correl. 37% Best - Worst 116% Best - Worst 110% Best - Worst 225% Best - Worst 68% 1940s 1950s 1960s 1970s Spain 140% Germany 739% Spain 312% Korea 456% Equal Weight 138% Japan 662% Australia 148% Japan 66% Australia 132% Italy 484% Equal Weight 75% Canada 30% United States 122% France 484% Japan 74% Equal Weight 10% United Kingdom 117% Equal Weight 384% Canada 71% United Kingdom 8% Canada 115% United States 376% United States 41% Switzerland -5% Sweden 100% Australia 277% Sweden 31% Australia -12% France -19% United Kingdom 270% United Kingdom 28% United States -17% Germany -35% Sweden 240% Germany 21% France -20% Canada 222% Italy -1% Sweden -22% Spain 98% France -6% Germany -31% Spain -69% Italy -74% 739% 739% 739% 739% Avg. Correl. 17% Avg. Correl. 20% Avg. Correl. 26% Avg. Correl. 38% Best - Worst 176% Best - Worst 641% Best - Worst 319% Best - Worst 530% © 2019 Bridgewater Associates, LP 4 1980s 1990s 2000s 2010s Sweden 503% Switzerland 231% Norway 48% United States 182% Korea
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