Evaluating the diversification benefits of the new country funds

Abstract

We seek to determine whether the addition of country funds to a typical U.S. equity portfolio gives as significant diversification benefit as purchasing foreign equities directly we compute the correlation between country fund and Sew York Stock exchange Index returns and compare this to the correlation between foreign equity investment and Sew York index returns. We plot the efficient frontier available to le US investor who can invest only in country finds versus that for the 1 Investor who can invest directly in the foreign equity markets that the Country Funds attempt to represent. We also look at the trading versus overnight return variances of the country funds. We find that the weekly correlation between country fund and New York Index is larger than the weekly correlation between dollar returns on the The difference is corresponding foreign index and the New York Index. particularly dramatic for Latin American, southern Europe, and Aslan funds. We also find that country fund return volatility is greatest when the New York market is open, not necessarily when the underlying countrys business hours occur. We conclude that these funds are not good substitutes for direct purchases of foreign equity This is particularly true for the more "exotic" countries which promise the greatest potential to diversify a U.S. equity portfolio.