Lack of Portfolio Diversification Makes Globalization a Risk for Western InvestorsAMERICAN INVESTORS ASK FOR A HEFTY 7% RISK PREMIUM WHEN INVESTING IN FIRMS EXPOSED TO TRADE SHOCKS AND THE SAME IS TRUE FOR EUROPE, ACCORDING TO A STUDY BY BOCCONI'S JULIEN SAUVAGNAT AND COLLEAGUES. THAT'S A VERY LARGE EFFECT, DICTATED BY THE RISK OF DISPLACEMENT OF LESS PRODUCTIVE LOCAL COMPANIES
Asset prices highlight that globalization is perceived as a risk by investors. Due to their lack of portfolio diversification, a new paper by Bocconi University’s Julien Sauvagnat and two colleagues finds, investors ask for a sizable premium when they invest in companies exposed to globalization. «The effect is truly large», Prof. Sauvagnat says. «The 7% annual premium we recorded is of the same magnitude as the premium asked by American investors to buy stocks instead of risk-free assets».
The scholars use shipping costs to measure firms’ exposure to globalization and trade shocks and, by analyzing return data of 5,854 American stocks in the 1975-2015 period, find that firms in low shipping costs industries have average annual returns that are 7% higher than those in high shipping costs industries. The premium seems to be commanded by the risk of displacement of the less productive firms in industries exposed to foreign competition.
When a trade shock occurs (foreign firms become more productive, and hence more competitive in the local market, for example), local investors experience both a price effect and a wealth effect. In the example the price effect is positive, since goods’ prices are reduced, and the wealth effect could theoretically have any sign. When investors have a diversified portfolio, with both national and foreign stocks, the effect could be positive or null, but it’s negative when investors only detain national stocks. «A positive risk premium for more exposed companies means that investors’ portfolios are not diversified enough», Prof. Sauvagnat comments.
The scholars repeated the analysis in 16 European countries and the globalization premiums almost perfectly match the American one, suggesting that their analysis is robust and that the lack of diversification affects not only American investors.
«In years of declining shipping costs and raising exposure to trade shocks, less diversified portfolios are vulnerable and a global diversification could be necessary», concludes Prof. Sauvagnat.
Jean-Noël Barrot, Erik Loualiche, Julien Sauvagnat, The Globalization Risk Premium, in early view, The Journal of Finance, doi: 10.1111/jofi.12780.
by Fabio Todesco