Question

International mutual funds do not include any domestic assets, whereas global mutual funds include both foreign and domestic assets. How might this difference affect their correlation with U.S. equity mutual funds? If you were investing in mutual funds, what type of funds would you invest in to diversify your portfolio?

Answer 1

International mutual funds include only the foreign assets while global mutual funds include both foreign assets and domestic assets (US assets).This means that while international mutual funds are not directly impacted by movements in asset prices in the US but global funds are directly impacted by movements in US markets since their portfolios include US assets.

Correlation between US mutual funds and global mutual funds

More the exposure of a global fund in the US markets, more would be it's correlation with US mutual funds. This means that the global funds which have a part of their portfolio invested in US assets would have that part perform similar to the performance of the the US mutual funds. Therefore, there will be a direct correlation between performance of the US mutual funds and the global mutual funds which have a segment of their portfolios invested in the US.

Correlation between US mutual funds and international mutual funds:

Since, international mutual funds don't have direct investments in the US assets, it's performance will not be directly impacted by the movements in the US markets. However, it's important to note that we live in an era of globalisation where all economies and markets are interdependent on each other. E.g- if US markets go down and US economy performs poorly, the Indian IT companies that export services to the US businesses would perform badly too. Therefore, an international mutual fund invested in that Indian IT company would get indirectly impacted by the movement in the US market even though it has no direct investments in the US.

Therefore, the correlation between US mutual funds and international mutual funds is normally not as high as the correlation between US mutual funds and global mutual funds but still they can definitely be impacted by the US markets (therefore possibilities of correlation with US funds) depending on how exposed international funds' portfolio companies are to the performance of the US economy.

Which type of mutual fund to invest for diversification:

If diversification is the focus of the portfolio, than investments should be made in a global mutual fund that has an optimum allocation of different sectors/businesses all around the world. i.e., the portfolio's allocation should be diversified geographically as well as into different industries.

Further, a fund that has a desired allocation between equities and debt would be better than a portfolio with all its eggs in just one asset class.