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Global Risk Diversification, Managers of the Decade, and More

A roundup of investment news.

Morningstar Analysts, 02/23/2010

The Reality Behind Global Risk-Diversification
One of the reasons that advisors look at international investments for their clients' portfolios is risk diversification. Historically, the risk-diversification benefits of international markets have come from their reasonably low correlation with the U.S. market. According to Morningstar's research and communications manager Jim Licato, however, the correlation between the U.S. and international markets has increased significantly in recent years. What can investors expect going forward?

The image illustrates the 60-month rolling correlation of U.S. stocks (represented by the S&P 500) to international stocks (represented by the MSCI EAFE Index). The graph shows the recent rise in the correlation between the two asset classes, suggesting that the benefit of diversification has suffered in recent years. The maximum benefit would have come in the 60-month period that ended in July 1987, when the cross-correlation was 0.26. On the other hand, the smallest diversification benefit would have come in the 60-month period that ended in October 2009, when the cross-correlation was 0.91. The monthly average over the entire time horizon was 0.60.

(View the related graphic here.)

An efficient frontier, consisting of only domestic stocks and domestic bonds (represented by a 20-year U.S. government bond), can be generated in an effort to identify the combinations of stocks and bonds that maximized expected returns for a given level of expected risk (or that minimized expected risk for a given level of expected return). If one were to expand the set of assets in a portfolio to include international stocks, an improvement in the risk/return trade-off is apparent. The improvement in the risk/return trade-off is primarily a result of the rather low correlation between international stocks and U.S. stocks over a majority of the period analyzed. As a result, points on the global frontier offered higher returns per unit of risk than points on the domestic frontier. Although the diversification benefit and risk/return trade-off have suffered of late, recent trends may not be indicative of future performance.

(View the related graphic here.)

Advisors, Morningstar Pick Managers of Decade
Before Morningstar's fund team named Bruce Berkowitz, David Herro, and Bill Gross its Fund Managers of the Decade, Morningstar Advisor asked advisors who, of the finalists for the official Morningstar awards, their favorite managers of the past 10 years were. The results of the poll were unequivocal--all three winners were of the landslide variety.

(View the related graphic here.)

At the helm of Fairholme FAIRX since its inception in December 1999, Berkowitz has seen the fund grow from a few million dollars in assets to more than $10 billion today. Berkowitz's strategy has led to a stellar long-term record, and his large cash stakes have helped limit volatility: Fairholme earned a 13.2% 10-year annualized total return through Dec. 31, 2009, beating the S&P 500 by 14 percentage points. Morningstar also named Berkowitz its 2009 Domestic- Stock Fund Manager of the Year, and Fairholme is a Fund Analyst Pick.

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