Financial issues

So, how did investment into the stock markets of different countries perform historically? Table I.2 describes the performance of various MSCI stock market returns over the last 35 years and over the last 20 years. It also shows the performance of two more global indexes, one being the equal-weighted index of the preceding 14 countries in the table, and the other being the MSCI World index.
Reward Even though the last three decades were terrific years for the U.S. stock market, it appears that foreign stock markets performed almost as well, if not better. (An important factor is, of course, that the dollar generally depreciated over these years.) Scandinavia and Hong Kong beat the U.S. market handily. Not all countries did, however—Canada, Singapore, and Japan beat the United States only over the full 35 years, not over the last 20 years.
Risk Contribution All foreign stock markets had betas with respect to the U.S. stock market below 1. Austria and Japan were particularly helpful in diversifying U.S. market risk; Canada, Hong Kong and Singapore less so.
Over the full 35 years, the equal weighted index of the countries also performed better than the U.S. stock market, although with equal volatility. The MSCI world index was safer than the U.S. stock market, although it sacrificed a tiny 3 basis points per month performance. In the second half, both world indexes had lower risk, but only the equal-weighted portfolio outperformed the U.S. stock market.
Risk Contribution vs. Reward Relation Would investing in these countries’ stock market portfolios have offered U.S. investors a high enough rate of return to make at least a small investment of international investing worthwhile? To answer this question, we use a U.S. CAPM formula. The market-beta of each country’s stock market with respect to a U.S. stock market index is the measure of how much reward our foreign stock market has to offer for its risk contribution/diversification. Alas, to use a CAPM formula, we need an estimate for the appropriate risk-free rate in U.S. dollars. Reasonable choices would be about 0.4% per month (5% per annum) over the last 35 years, and 0.3% per month (4% per annum) over the last 20 years. Therefore, the ex-post CAPM in the United States was something like 1970 − 2005 : E ( ˜ ri ) ≈ 0.4% + (0.95% − 0.4%) · βi,M 1986 − 2005 : E ( ˜ ri ) ≈ 0.3% + (1.07% − 0.3%) · βi,M (I.4)
So, against these formulas, how did our specific countries perform for a U.S. investor?
The majority outperformed! For example, according to a U.S. CAPM, Austria should have earned about 0.3% + (1.07% − 0.3%) · βaut = 0.55% per month in the most recent 20 years. Instead, it offered about twice this average return. Only Canada and Singapore did not outperform. Even Japan, which had the lowest average stock market returns, still outperformed, because its U.S. beta was low.
Of course, when it comes to data, you must always be cautious: being ex-post actual data, these are only approximate relationships, not even historical expected relationships—and much of the strong historical performance of foreign markets was due to the weakening of the dollar, which is not necessarily expected to repeat. Furthermore, it could also matter what specific stock market index and risk-free rate we are using for each country, just as it matters which exact sample period and foreign stock market indexes we choose, and that we have ignored taxes and transaction costs. Moreover, although the sample suggests that international diversification has worked quite well and that the OECD country indexes had low betas with respect to the U.S. stock market, this empirical relationship seems to have changed in recent years. The OECD countries’ stock indexes seem to now be covarying more strongly with the U.S. stock market—perhaps a sign of increasing financial integration. Nevertheless, even if international diversification no longer works as well as it has historically, chances are that it is still a good financial choice.
In sum, the evidence suggests that investing in OECD countries offers decent diversification  benefits. And fortunately, widely available international mutual funds have made it very easy to obtain these modest diversification benefits. But many investors do not take advantage of them.
The jury is still out on the diversification benefits and expected rates of return from investments in “emerging markets” (developing countries). Many of these emerging markets did not exist or were not easy to access for U.S. investors just twenty years ago, but have only recently come online in a form that a typical U.S. retail investor can take advantage of (i.e., with country-specific mutual funds).