Do international index funds provide diversification to domestic USA index fund?
Let's examine two exemplary passive index funds. One is international and one is USA domestic.
SCHF: Schwab International Equity ETF
SPY: SPDRŽ S&P 500 ETF
Does the international index diversify your portfolio?
The purpose of diversification is to buffer losses in one investment with gains in another investment. I think to diversify, the markets that these companies operate should be as distinct as possible. These two types of index funds don't seem to operate in distinct markets. There's too much overlap, which means not much diversification.
The top 10 holdings of SCHF are:
NESTLE SA REG
NOVARTIS AG REG
SAMSUNG ELECTR GDR
HSBC HOLDINGS PLC
ROCHE HOLDING AG GENUSSCHEIN
TOTAL SA
TOYOTA MOTOR CORP
ROYAL DUTCH SHELL PLC A SHS
BP PLC
ROYAL DUTCH SHELL PLC B SHS
It's true that these companies are headquartered outside of the US, but many do business inside the US. Nestle sells food in the US. Toyota sells cars in the US. Samsung makes the majority of phone screens sold in the US. Consumer behavior in the US will have an impact on these companies.
The top 10 holds of SPY are:
Apple Inc
Microsoft Corp
Amazon.com Inc
Berkshire Hathaway Inc B
Facebook Inc A
JPMorgan Chase & Co
Johnson & Johnson
Alphabet Inc Class C
Exxon Mobil Corp
Alphabet Inc A
Apple phones are popular in a lot of Asian countries. Microsoft Windows is the operating system of choice around the world. Facebook and Google (Alphabet) are accessible from anywhere with internet (okay, so they're banned in China, but permitted in most countries).
Is the performance of these two funds correlated?
When one investment "zigs", you want the other investment to "zag". You don't want all your investments to crash at the same time. I'm not seeing these two funds move in opposite directions for the most part. The movements of these two graphs look quite similar. Anytime the US dipped, the international one dipped too.
There's an anomaly in 2018. The US fund has been growing and the international one has been dropping. It might have something to do with the trade tariffs. Is this truly the beginning of the anti-correlation?
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There are various types of diversification - stock weighting, sector weighting, geographic (domestic, international), by asset class (stocks, bonds, real estate, commodities), by strategy (cap size, sorting).
Your two funds are diversified by geography. Other than that, as you noted, they have a lot of overlap. I randomly opened an online correlation calculator and it indicated that the daily, monthly, and annual Standard Deviations as well as the Rolling Correlations over the past 10 years are similar. These are fairly highly correlated funds.
Diversification is not just about canceling out risk via anti-correlation. Even when two assets are positively but not perfectly correlated, their combination somewhat reduces volatility. Another perspective is that the perfect diversification in theory is the "market portfolio" consisting of all traded assets at market cap weights. Most individual assets are positively correlated with the market portfolio, reflecting a common fluctuating factor ("systematic risk"). Diversification can only mitigate the other, specific/unsystematic risks.
Indexes provide diversification since they invest in more then one stock, especially big ones like the S&P 500 who have 500 hundreds big companies inside. Yes most of those enterprise are internal focus, on the US index and the non us index.
But often have more values in there local market, which gives advantage through the impact of different currency and maybe a big catastrophe in one country.
Another point of diversification, is locking on the distribution of the investment. The Sp500 have 25% IT enterprises in it, with could be a bit much if your other stocks are also in that area but IMHO nothing to worry if this is your only one you are investing in.
I also like the msci World, who still have lot of US companies inside but tons of sectors and stock included that it is a good blue ship profolio for itself.
About the correlation i can not say much, they will affect each other a bit. They have already a good spread, and could be considered a good relative risk free investment itself.
Edit: sry i thought in the beginning it was an Sp500 like non US index with 500 non us blue chips.
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