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Aren't developing markets particularly risky?
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Yes. There is no question that developing markets are risky. However, there are over 50 markets in the world. The problem is that investors frequently equate non-U.S. markets with developing markets. The Island Principle encourages investors to make the most of their investments in the world's 21 developed markets and to invest relatively little in riskier developing markets.
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How can adding a risky investment to a portfolio actually make the portfolio itself less risky?
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This is the magic of diversification*. It is a very, very powerful but little understood tool. Inherently people know that they are safer if they do not put all of their eggs in one basket. Modern Portfolio Theory formally demonstrates why this is true using complex formulas that need computers to run the calculations. With these formulas you can show that an investor can add a risky, high returning investment to a portfolio and expect to actually both increase returns and decrease risk if the investment has a lower or negative correlation with the portfolio. The Island Principle provides an easy to understand explanation of how diversification works.
(* Be aware that diversification does not assure a profit and does not protect against loss in declining markets)
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What index should islander investors use to track portfolio performance?
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The challenge for the island investor is to move away from worrying about the Dow, S&P 500, or the NASDAQ, even though this is what is reported, seen, or heard on the news every night. When the U.S. market represents only a portion of their portfolio, the importance of these indices diminishes. All the other major indices have inherent problems for the island investor. The best benchmark may be the MSCI World Index or the average performance of all global mutual funds. But The Island Principle makes the point that investors should rarely strive to match an index. Many investors do not understand this.
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How can an individual investor find the research resources to make decisions about global markets?
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Conducting adequate research on U.S. companies is a challenge in itself. Researching foreign companies with different languages and accounting systems and all the idiosyncrasies of foreign stocks is much more complicated. Following The Island Principle, investors use the much simpler approach of using global, professionally managed investments. Those chosen should have in-depth research teams as part of their staffs that can handle the many complexities of foreign investing. Investment companies and many portfolio managers are positioned to handle the complicated matters regarding buying and selling securities in non-U.S. markets and for dealing with currency and politcal risk, as well as varying accounting standards. The financial industry deserves special credit for making it possible for individual investors to invest outside the U.S. through various professionally managed investments.
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If management diversification is a key to an investor's portfolio as other kinds of diversification, how can an individual investor with a smaller portfolio get the attention of global managers?
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Again, professionally managed investments that offer global options are the solution. One of the advantages is that even with a portfolio as small as $10,000, investors can diversify using five or six different managers. This type of diversification is not otherwise available to an investor.
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If The Island Principle works, why aren't more investors putting large amounts of non-U.S. stocks in their portfolios?
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Investors have slowly increasing the portion of non-U.S. stocks in their portfolios. It is interesting that with investing where there is such an emphasis on new ideas and demand for performance, that foreign investing has been slow to catch on. Clearly part of the reason has been the excellent returns available in U.S. markets, (even though the U.S. has not been the best performing market since 1970 when data has been collected). Also, the Financial Industry Regulatory Authority requires that brokers warn investors about the inherent risk of owning foreign stocks. Brokers must say something like "Foreign investing carries special risks including political risks, currency risks, and different accounting standards." Even though U.S. investing carries many of the same risk, the warnings make investors leery of non-U.S. investing.
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Where do I find out more about The Island Principle?
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The Island Principle is presented in Getting Started in Global Investing by Robert P.Kreitler (John Wiley & Sons Inc., ISBN 0-471-38524-7). The author can be reached at Kreitler Associates/Raymond James Financial Services, 195 Church Street, 11th Floor, New Haven, CT 06510; 203 867-4396 voice; 203 867-4398 fax; by e-mail at robert.kreitler@raymondjames.com.
