That matters too. If returns from different asset classes are independent-ish, that will reduce the volatility of a portfolio's returns without hitting its overall performance for the simple reason that the value of some assets will rise when others are falling. So investors are doubly compensated for tolerating the volatile performance of emerging markets equities. Not only do emerging markets bring excess returns in the long run, but - within a diversified portfolio - their effect is to improve the risk/return trade off.
Caveat number one is that it has been known for years that the prices of all financial assets are much less independent of each other than bits of portfolio theory would wish. The extreme effect of that mutual dependence may even be that it's not worth the bother of constructing diversified portfolios in the first place.
Caveat number two is that the financial crisis of 2008-09 dealt a further blow to the notion of independent asset prices. Up till then at least it was believed that the performance of the more esoteric assets would be independent of the major equities markets. So private equity would be a good hedge as would securitised debt or even works of art. But the crisis proved the sad truth that, when the ability of buyers to pay up is sufficiently undermined, it hits the value of almost all assets simultaneously, especially those whose liquidity is shallow.
Still, that describes a situation in melt-down and, almost by definition, financial markets rarely melt down. Maybe it happens more often than conventional wisdom admits; even so, it's comparatively rare. That allows us to cling to the hope that diversification works up to a point.
Caveat number three is that the International Monetary Fund (IMF), the world's central bank, has been doing research into financial spillovers and especially the relationship between equity-market returns in 13 Asian/Pacific economies and the developed world. The results are interesting.
The IMF's starting point is that it has long been clear there is strong integration of the trading fortunes of developed and developing economies. It is also clear that China's financial markets increasingly influence events throughout Asia. However, what is under-researched is the inter-dependence of equity returns between developing Asian countries and the developed world.
The IMF's so-called 'spillover' index aims to rectify this. It measures not just the size of a shock in a country's equity-market returns, but the direction in which the shock moves. In other words, it measures the size of shock transmitted from one country to all the others (the outward spillover) and the shock that a country receives from all the others (the inward spillover). The net of the two indicates the extent to which a country's equity market moves in response to external stimuli - if you like, it's a price taker - and the extent to which it causes others to move (is a price maker).
The main findings are:
■ The spillover of both equity returns and volatility has increased substantially in all directions since the financial crisis, though it has moderated in the past two years.
■ That makes for a fuzzier picture, but there also appears to have been a role reversal since the crisis. Markets in developed economies have become much less net givers of spillover. Simultaneously, the developing markets - and especially China and the 'Asean 5' (Indonesia, Malaysia, Philippines, Thailand and Vietnam) - are increasingly the net givers.
■ For Asian markets, the change in their net position is chiefly because fluctuations in their markets increasingly appear to drive changes in global markets. Put another way - the direction and scale of movement in developed-country equity markets increasingly tends to lag changes in developing Asian markets.
■ The IMF speculates that the increased spillover from Asian markets is linked to the region's growing financial integration. This has deepened since the financial crisis as the presence in Asia of European-based banks has faded to be replaced by the expansion of Japanese and Chinese banks.
In a sense, it all seems logical. To simplify and exaggerate - economically, the tired West is giving way to the energised East so it seems only natural that the financial markets of the fast-growing region will eventually gain sway over the direction and volatility of markets in the slow-growth region.
In practical terms, that notion may be too simplified. After all, it's not as if the economic and financial hegemony of the US - and the attractions that stimulates for its financial assets - is about to vanish; and patterns in financial markets - who leads and who lags - are often too confused to offer clear lessons.
Even so, first assume that over the long haul the economies of east Asia will be among the world's fastest growing and, second, that therefore their equity markets will produce more good news than bad. Taking those assumptions, then the IMF's findings only add weight to the idea that a substantial presence in east Asian equities is almost compulsory for any investor from the developed world who has a sufficiently long investment horizon - say, 10 years - and the stomach for the volatility.
