by Marshall Blume
Over the past several decades the cumulative return realized by US stocks has exceeded the cumulative return realized by international stocks. Yet, PMA, as well as other investment managers, still maintains investments in international stocks.
First, in investing, the long run is a series of short runs, and random events in the short run can produce big differences in final outcomes. Although US stocks have sometimes outperformed international stocks, the opposite easily could have occurred. Second and more importantly, international stocks deliver significant benefits from diversification.
This note will explore these concepts in a bit more detail. First, we will demonstrate that past returns for US and international stocks are of no use in predicting future returns. Second, we will show that international stocks provide significant benefits in diversifying a portfolio and thereby reducing the risk of a portfolio. Third, we will review the importance of estimating future expected returns in determining a reasonable allocation for risky assets.