Concept

In: Business and Management

Submitted By babiitiger
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Pages 6
Investing in foreign securities, while a good thing for your long-term portfolio, continues to pose new threats for investors. As more people broaden their investment universe by expanding into foreign stocks and bonds, they must also bear the risk associated with fluctuations in exchange rates.

Fluctuations in these currency values, whether the home currency or the foreign currency, can either enhance or reduce the returns associated with foreign investments. Currency plays a significant role in investing; read on to uncover potential strategies that might downplay its effects.

Pros of Foreign Diversification
There is simply no doubting the benefits of owning foreign securities in your portfolio. After all, modern portfolio theory (MPT) has established that the world's markets do not move in lockstep and that by mixing asset classes with low correlation to one another in the appropriate proportions, risk can be reduced at the portfolio level, despite the presence of volatile underlying securities. As a refresher, correlation coefficients range between -1 and +1. Anything less than perfect positive correlation (+1) is considered a good diversifier. The correlation matrix depicted below demonstrates the low correlation of foreign securities against domestic positions.

Monthly Correlations 1988 to 2006

Security Type S&P 500 Index Russell 2000 Index Russell 2000 Value MSCI EAFE International Small Cap International Small Cap Value MSCI Emerging Markets
S&P 500 1 - - - - - -
Russell 2000 0.731 1 - - - - -
Russell 2000 Value 0.694 0.927 1 - - - -
MSCI EAFE 0.618 0.532 0.487 1 - - -
International Small Cap 0.432 0.466 0.414 0.857 1 - -
International Small Cap Value 0.41 0.411 0.414 0.831 0.97 1 -
MSCI Emerging Markets 0.59 0.634 0.586 0.582 0.53 0.512 1
Source: Dimensional Fund Advisors

Combining foreign and domestic assets together tends to…...

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