Note: This article is part of Morningstar's March 2015 ETF Investing Week special report.
Foreign developed market stocks can offer reasonable diversification benefits to Canadian investors. Including them within a portfolio may help diversify away risks linked to local markets, interest rates and currencies. For example, the risk of rising interest rates may be smaller in Europe and Japan than in Canada. The asset class also tends to offer greater exposure to defensive sectors such as consumer defensive and healthcare than most broad Canadian index funds, which may help improve diversification.
That said, investors should keep in mind that foreign developed-market large-cap stocks are typically global firms that increasingly generate a majority of their revenue outside of their home country or region. As a result, the performance of the asset class is tied to the health of the global economy. As the global economy has become increasingly integrated, correlations across markets have increased. In the 1990s, the trailing three-year correlation between the monthly returns of the MSCI EAFE Index and the S&P/TSX 60 Index was 0.4. Today, the correlation is more than 0.8. However, that is no reason to abandon global diversification.
