Diversification Using International Exchange-Traded Funds

Diversification is the process by which a portfolio is constructed to minimize risk and maximize return. Exchange-Traded Funds (ETFs) are diversified portfolios of assets which trade like stocks and track a benchmark index. Financial theory suggests that all portfolios benefit by diversifying through many different asset classes and geographic regions; this lowers the portfolio’s overall risk profile. My research focuses on geographic diversification to examine the diversification and return benefits a U.S. investor would receive by investing in Emerging market (EEM) and Total World (DGT) ETFs over the period of June 2003 to July 2019. We use the S&P 500 ETF IVV as a proxy for U.S. market. EEM had the highest absolute return but also the highest risk. However, the U.S. ETF IVV had the greatest risk-adjusted return and the lowest tracking error. International ETFs were also highly correlated with the S&P 500. Overall, results indicate that U.S. investors receive limited diversification benefits through international ETFs.