Investors should spread their equity investments around the world – but not perhaps for the reason you might think.
International diversification is no way to spread short-term equity risk. In March, for example, the All-Share index fell more than 13 per cent as the pandemic struck. But emerging markets fell as much, and US and continental European markets fell more than 10 per cent in sterling terms – falls that were cushioned by the drop in the pound. Wherever you had invested, you lost money quickly.
Such co-movement is typical. If we look at monthly price moves in sterling terms since 1997 the correlation between UK and US stocks has been 0.79 and that between UK stocks and MSCI’s Europe ex UK index has been 0.87. Such big numbers tell us that major stock markets rise and fall together in the short term. You cannot therefore reduce short-term equity risk much by spreading your investments overseas. If you want protection against such risks, you need non-equity assets such as cash, bonds, gold or foreign currency.